Dollar dreadnaught dings dong

Yesterday’s WSJ, which I just got around to reading today, has an interesting article on the effects of the strong dollar on coffee production around the world, “Strong Dollar Skews Coffee Trade.” It leads with a touching story of Vietnamese farmer Y Kua Mlo storing his coffee crop in his bedroom rather than putting the crop on the market because the price in dong, the national currency of Vietnam which is the world’s second largest coffee producer, is depressed because the dong is tied to the dollar. The world’s largest coffee producer Brazil’s currency has, however, dropped, making its coffee cheaper. Meanwhile, production in Brazil is soaring because the real ($R) price is up. “Coffee prices have been painfully low, and none of us want to sell the beans now,” Mr. Mlo moaned. (The market price is 34,000 dong ($1.52/kilogram) but he is holding out for 40,000.) Mrs. Mlo says he should have switched to peppers, so there is probably a lot of tension in the coffee bean-stuffed bedroom.

Vietnam, like the other countries whose currencies are tied to the greenback (China, Hong Kong, Saudi Arabia, Panama, etc. – the list grows ever shorter) are in increasing difficulties, as is the United States itself. I would expect that the market will bring the dollar down soon, particularly as the 10-year bond yield differential is diminishing. (Assuming of course the Fed does not tighten further.)

El-Erian fears doom, but hopes for the good enough

Mohammed El-Erian has just published a book, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. He says the world economy is on a road heading for a "T junction," to use a British phrase. We must soon choose between the two roads. One leads to total destruction (depression, social disorder) and the other to some sort of survival. He assigns a 50% likelihood to each outcome. To achieve the latter somewhat better outcome, far-sighted, enlightened and public-spirited actions are required from our leaders. (It is unclear how he gets a 50% likelihood that this will happen. It's rather like Samuel Johnson's definition of a second marriage, "the triumph of hope over experience.")

As for the central banks, we have reached the point where a continuation of extraordinary measures (ZIRP, QE) is counterproductive, and even destructive. He goes so far as to say that apart from the emergency measures during the crisis, the central bank monetary manipulation experiment has not worked.

Yesterday my wife listened to El-Erian's hour-long interview on Tom Ashbrook's show "On Point" in the morning. She insisted I hear the replay in the evening, but I resisted as I was reading a book. I did, however, subsequently download and listen to the podcast. It is well worth hearing. It is anything but the party line.

The link: http://onpoint.wbur.org/2016/02/16/economic-market-crash-prediction


Yours truly,
Lincoln

Central bankers among the wolves

Last week Janet Yellen talked to Congress and on Monday Mario Draghi spoke to the European parliament. I happened to watch some of each on TV.

Janet Yellen probably regards her recent testimony to Congress as a low point, at least so far. Like Rodney Dangerfield, she got no respect. (“I come from a stupid family. During the Civil War my great uncle fought for the West!” – NB: I think that was said by Dangerfield, not Yellen.) Gone are the halcyon days of the representatives’ and senators’ groveling and obsequious boot-licking of Greenspan and Bernanke. The image that came to my mind was the movie scene where the caveman, or, in this case, cave-chair finds herself alone at night surrounded by a pack of hungry wolves held at bay only by the sputtering flames of a dying torch. The wolves respect the flames but not the chair, and they know the flames are dying. I was half expecting a band of loyal governors to rush into to hearing room at the last minute to rescue her, but they didn’t.

Mario Draghi looked more impressive, speaking with assuredness, surrounded by well-groomed advisors in Italian suits, until the Q&A, when the camera turned and revealed that the large parliamentary room was almost empty. Draghi gave his usual “we’ll do what it takes” and even boasted that half of the Eurozone’s growth has been from ECB actions. (The other half was, according to him, from low oil prices, leaving out government, policy, individual initiative, invention, and hard work, all of which are of no account, at least in Mario’s mind.) I couldn’t help thinking that he keeps saying he’ll do “whatever,” but in reality he does rather less than his words suggest. No doubt there are some puppet strings leading to the restraining hand of Wolfgang Schäuble, just offstage.

For several years at least, people have been reassured by the assumption that the central banks have matters under control. Now that doubt has crept in, who or what will be the new repository of hope? So far, the political leaders are AWOL and have been a long time. Nature abhors a vacuum. This has the makings of a crisis.

What China yuans, China gets; my humble and beneficent exchange rate forecast

Mr. Kyle Bass of Hayman Capital Management has, according to the Wall Street Journal, a multibillion-dollar bet against the Chinese yuan (money), the renminbi. In an eleven-page letter to investors that was cited in the Journal, Bass reported that his fund had sold off the bulk of its other investments to concentrate on shorting Asian currencies. What caught my attention, and the attention of many other investors, was the following quote from Mr. Bass: “The view that China has years of reserves to burn through is misinformed. China’s back is completely up against the wall today. . .” Bass justified his view with the fact that China’s liquid reserves were “only” $2.2 trillion at the end of January compared to its total reserves of $3.23 trillion.

The use of the words “only $2.2 trillion” is interesting in light of the facts that the total reserves including gold of the UK are only $107 billion, of the US only $434 billion (almost all illiquid gold), of Germany only $193 billion, and so on. (This is from the latest World Bank data at http://data.worldbank.org/indicator/FI.RES.TOTL.CD .) China’s liquid reserves of “only” $2.2 trillion are huge in comparison. Of course, Bass can be excused for a bit of hyperbole since it reflects his investment position and thus may be of near term benefit to his investors.

Bass will probably make a lot of money on his short because his investment strategy is not at odds with the policy of the People’s Bank of China (PBOC). Between the Asia crisis of the 1990s, when the renminbi was devalued, and 2005, China tied the renminbi to the US dollar, much to its benefit. Then, until 2005, it followed a policy of gradually increasing the value of its currency relative to the dollar. This policy has had bad consequences for China because the US dollar has been strengthening, dragging the renminbi up with it to a very overvalued position. The negative consequences were aggravated by the large devaluations of the currencies of China’s main trading partners other than the US, which has left China with an even greater overvaluation than the US.

So in December 2015 China announced it would no longer track only the dollar but rather a trade-weighted basket. China can be expected to adjust gradually its currency valuation again this basket to bring the renminbi back in line with other currencies.

The BIS has created trade-weighted indices of many currencies based on each country’s individual trade relationships. The graph of the US dollar, the renminbi, the euro (based on Germany’s trade), and the yen shows that the renminbi has risen considerably against all them since 2010. (About twice as much against its basket as the US dollar against its.) (This is not to say whether or not the renminbi is overvalued in some absolute sense, but only relative to where it was five years ago.)

Were it to regress to the mean, the renminbi would depreciate about 30% on a trade-weighted basis. So here is a crude forecast: Both the US dollar and the renminbi will likely depreciate on a trade-weighted basis, China by 30% and the US by 15%, so China will depreciate 15% in dollar terms. The renminbi/dollar is now 6.53 yuan/dollar; in this scenario our guess is that that rate will be about 7.50 at some point. This is a big move, but I am guessing that this is in the ballpark of what the PBOC is targeting. They will, of course, proceed by baby-steps, like the mincing gait of the women with bound feet in the old imperial court. But proceed they will. In the words of Lao Tzu, “The journey of a thousand miles begins with a single step.”

Going postal, and liking it

In recent years I have noticed that the service provided by the US Postal Service has improved a lot. Most letters I send to people in Massachusetts seem to get there in the next day or two, and letters to the rest of the country take two or three days. This is a far cry from thirty years ago when a letter to New York City from Boston could take a week or ten days, or three days, or five days (one never knew), while a letter to Washington usually took three days, but not always. The post office performance had been unpredictable, but now it has become fast, cheap and reliable.

I remembered this when I saw an article in the Wall Street Journal this morning on page B4, “Postal Service is Profitable.” It said the postal service in Q4 2015 earned $307 million and had its first quarterly profit since 2011. It also delivered 660 million holiday packages more than either UPS or Fedex and more than it had forecast. In fact, the post office is gaining market share from these rivals.

This interested me enough to glace at the post office FY 2015 report to Congress. In FY 2015, USPS revenues were up 1.6% to $68.9 billion, employees numbered 491,863, flat from the previous year, mail deliveries were down 1% to 154.2 billion pieces, and packages were up substantially to 4.53 million from 3.96 million. (+14%)

The USPS reported a net loss of $5.1 billion in FY 2015, about the same as in the two previous years, so the 4th quarter profit is particularly notable. It should be remembered that the USPS has been subject to unique charges by Congress. Unlike ordinary corporations, the service is required to amortize over a ten-year period the PSRHBF Prefunding Expense, which is the present value of the future health benefits of future retirees; this amount exceeds $5 billion/year. The service must also credit toward the pension of any military veteran it hires his full number of years of military service as if they were years at the post office; this transfers liabilities from the Department of Defense to the Postal Service and represents a subsidy to the defense budget.

So the post office is not in bad shape and it’s getting better. It has stopped shrinking and is growing slowly. One may conclude that a government-owned corporation can be efficient when subject to competition. This is one of those rare instances in which the thesis propounded by John Kenneth Galbraith in The New Industrial State has been realized, at least partly.

But what of UPS and Fedex? I remember reading years ago that Fedex had made few inroads into the domestic Swiss market because the post office there was fast, reliable and lower cost. I wonder if this sort of competition will develop in the US to an even greater extent than was evident during the holidays. I wonder if a similar threat exists in other markets, like Canada and the UK?

Marketwatch headline on Japan reveals the true situation

It makes we wonder what, with Rodan on the rampage, will Godzilla (BOJ) do?

Rosenberg's case for inflation rather than deflation

Decades ago, when economist David Rosenberg was with Merrill Lynch, from time to time he used to come by the offices of the firm in Boston where I worked. He came to talk about interest rates and the markets in general.  He was always respected by the cognoscenti for his knowledge, intelligence, and common sense, so we always looked forward to learning what he had to say.

Because of this, when he was on Bloomberg Surveillance on Thursday, I paid attention, and all the more so as I realized he was making the case that we will be surprised when we realize that inflation is much higher than assumed. "Don't worry about deflation," he argued.

The key points that stuck in my mind were that service sector inflation is already at 3% and that bank lending is now growing rapidly.  Here is a clip from his much longer interview.

(Here is the full hour from Bloomberg Surveillance, which deals with many things.  The inflation discussion begins around 1:22 .)