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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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The Fed raises and lowers monetary growth and interest rates by adjusting its own balance sheetTHE FED AND THE DOLLAR How big was the demand for dollars by holders of the expiring European currencies? The best way to measure it is to take the year-over-year growth of the currency component of American M-1* and subtract it from the year over-year growth of the American Monetary Base. For the year beginning the end of July 2001, the currency component of M-1 grew by $132 billion, and the Monetary Base grew by $135 billion. That background leads to a discussion of what the Fed does and how it does it. The Fed raises and lowers monetary growth and interest rates by adjusting its own balance sheet. It holds U.S. government debtplus some minor miscellaneous items, like the gold in Fort Knox. Its main liabilities are currency in circulation and U.S. bank reserves. (It creates bank reserves by buying U.S. government debt, primarily Treasury bills, and it reduces reserves in the system by selling U.S. government debt.) Everyone in the world knows the Fed slashed interest rates and grew the money supply after September 11. Except that it did not do it by growing bank reserves, which is the monetary method for moving a torpid economy. Reserves grew with the glacial speed associated with prerecessionary periods of Fed tightening. The Feds supposed activism was confined to printing all that paper money, which has no multiplier effect on the economy. What happened to that money and why was it suddenly in demand? Did Americans stop using credit cards and bank charge cards? Did drug lords quadruple their sales, thereby increasing their cash holdings? Of course not. The most reasonable explanation is that the huge demand for greenbacks from foreign exchange traders who were absorbing expiring European currencies created extraordinary demand for dollars. Anecdotal reports from foreign exchange traders confirm this sustained rush into dollars by those who wished to retain some confidentiality about their affairs. *Bank and other short-term deposits plus currency in circulation. Another aspect of that puzzling piece of data is that it helps to explain why U.S. economic growth in 2002 was so disappointing. The Fed was actually not stimulating the economy, a point noted frequently by Dennis Gartman, a shrewd market commentator. The Fed was more spectator than actor in the dramatic events of 2001-2002. By most accounts, the Fed has kept the accelerator to the floor. It cut the Fed Funds rate 12 times. Isnt that monetary stimulus? Suppose you are managing a store in an outlet mall and your owner gives you a huge batch of merchandise to sell, telling you it must be sold within a few days. He comes by a week later and your store is still jampacked with the stuff. When he blasts you for not getting rid of it, you answer, I lowered the price 12 times in five days. Im doing my damnedest. To which he says, But you havent got the price down to the level where it clears. I dont care how many times you cut prices. Slash prices to the level where you unload the merchandise. The Fed Funds rates kept getting lower, but economic activity was sluggish, as indicated by weak credit demand and massive loan loss writedowns across the system. The Fed, relying on the statistics showing robust growth in the savings-oriented monetary aggregates, such as M-3 and MZM, didnt really move to counteract those deflationary forces. The problem with using those monetary aggregates to show Fed activism in stimulating the economy is that they are largely composed of large Certificates of Deposit (CDs) and Money Market Funds, not what Milton Friedman calls transactional balanceswhich are the banking components of M-2checking and savings accounts and small ($10,000 and under) CDs. These millions of little accounts are the monetary muscle of the day-to-day economymoney that is likely to be used in transactions, including the day-to-day expenditures for mortgage payments and trips to the supermarket, but also for discretionary expendituressuch as on trips, automobiles, furniture, and appliances. The multi-million-dollar CDs and Money Market Funds are mainly parking places for investment capital temporarily withdrawn from the stock and bond markets. They are savings accounts, not economic activity accounts. (The exception is corporate Money Market Funds arising from issuance of securities; these funds get drawn down within months after a bond or stock issue, but until actually spent, they stay in Money Market Funds.) The flaccid U.S. economy since 2000 is the seriously wounded victim of the drunken drivers of the tech binge. That interest rates have fallen so far, so fast, since then is more a measure of the collapse in demand of an imploding economy than the exploding expansionism of an aroused Federal Reserve. Had it not been for the euro conversion, the Monetary Base might not have grown at all, and every economist and strategist in the United States would have been screaming for the Fed to get moving to stimulate the moribund economy. THE DOLLAR BEAR MARKET BEGINS TO BUILD When the global reserve currency enters a major bear market, it tends to fall against nearly everything except the collapsing currencies of distressed emerging nations, such as Argentina and Brazil in 2002, or African kleptocracies. That the greenback fell against the yen in 2002 was a sign that the dollars problems were suddenly truly serious (see Chart 7-2). Japanese interest rates are submicroscopic, making the 1.75 percent return on U.S. Fed Funds look like a shoguns ransom. (Those tiny Japanese yields may help explain why the TED spread stayed very low in 2002, despite all the problems in U.S. financial markets and the decline in the dollar; eurodollar holders may have decided that a 1.75 percent yield with currency risk was better than .15 percent in Japanese deposits.) The Japanese government was alarmed, and sought to get the Bank of Japan to drive the yen back down by massive reliquification. The Bank of Japan resisted being drawn into another dollar-propping exercise such as it had engaged in after the 1987 crash (see The Nikkei Crash: 1985 to ? in Chapter 3), a reflation that drove the values of Japanese stocks and real estate to ridiculous heights, setting the stage for 12 years of deeply deflationary recessions interrupted by brief periods of modestly deflationary recoveries. But the Bank of Japan finally caved and began buying Japanese Government Bonds (JGBs). That got the money supply moving and increased the supply of yen, thereby holding back its rally against the dollar. That Japan sought to hold down its currency was natural: Just about the only segment of the Japanese economy showing good growth was the export operations of Japan Inc.the Sonys, Hitachis, Toyotas, Hondas, and Toshibas that make Made in Japan the standard of quality worldwide. Those five companies collectively stood to lose nearly all their corporate profits in 2002 if the yen were to rise to par (100) against the dollar. Lest the reader assume this is because Japan Inc. exists almost solely on sales to Americans, let me explain that the new powerhouse of mainland AsiaChinapegs its currency, the renminbi (or yuan) to the dollar. Because it holds more than 300 billion dollars in its exchange reserves, and it refuses to let the renminbi float in global currency markets, China, already the fastest-growing export-oriented economy in the world, grows faster and gains market share from its major competitor, Japan, when the yen rises in value against the dollar (see Chinas Impact on the Global Economy and Corporate Profitability, in Chapter 8 ). The yens rise was part of a new trend. Behind this trend was the changed attitude and growing numbers of a special group of investors. THE GROWTH IN GLOBAL INVESTING AND ITS INFLUENCE ON THE DOLLAR When you hear somebody speaking of a strong dollar or a weak dollar, what do they mean? What are they comparing it with? Those expressions generally refer to the dollars strength or weakness against a basket of foreign currencies. The U.S. Dollar Index is a collection of foreign currencies of leading industrial nations weighted in relationship to U.S. trade with those countries or regions. It is the index used by most forecasters when they say the dollar will be strong or the dollar will be weak. They arent speaking of its performance against Russian rubles or Brazilian reals. The dollars bull market was bound to turn into a bear market at some point, even if there hadnt been that fascinating last fling as the dollar danced with the artful millions who didnt want eurogovernments to learn their secrets (see Charts 7-3 through 7-5). Once the dollar entered a major bear market, a major bull market for gold would be born. What had been a major underpinning for the dollar during the 1990s would inevitably become a major threat to the dollar in this decade: global investors strategies. During the late 1980s and the 1990s, global investing for pension fund, endowment fund, and high net worth clients became a profitable, glittering business. During those decades, some of the best jobs in portfolio management for a Baby Boomer chartered financial analyst were with the fast-growing global investment firms and private banks based in London, Paris, Edinburgh, Zurich, Geneva, Luxembourg, Munich, Milan, New York, Fort Like all institutional investors, a London-based firm offering its services to pension funds and high-net-worth individuals worldwide needed to compare its investment returns to major indices. The S&P 500 wasnt appropriate, nor were such relatively small national markets as the German DAX or the French CAC 40. Morgan Stanley met this new need by creating three kinds of indices for globe-trotting investment firms: 1. Morgan Stanley Capital International: a global index that included stocks traded in most of the significant markets of the world, including the United States. . Europe, Australia and Far East (EAFE): an index that included the significant established markets outside the United States (except for Canada). Latin America wasnt included because its markets were all included in the third, Emerging Market, index. 3. Emerging Markets: an index that included dozens of countries from around the world. All they had to do was have a local stock market with enough transparency and liquidity to be measurable and they were counted in this subgroup of the world. In practice, foreign-based suppliers of services to U.S. clients concentrated on the latter two indices. U.S. pension funds and high-net-worth clients already had managers expert in U.S. markets, and they werent interested in paying offshorebased managers to figure out which U.S. stocks to buy. This industrys impressive growth in the 1990s was in part due to a new trend among Continental European pension plans to invest heavily in equities. Britain had pioneered the concept of prefunding private pension plans with heavy equity exposure, but it took a long time for the Continentals to make that move. A major reason for Europes rejection of equities for pensions was that private pension funds were insignificant on the Continent. Governments assumed the pension responsibility, and they used pension contributions from companies and self-employed persons to fund their deficits. That hangover from the dominance of Socialist thinking among euroelites in the 1950s and 1960s was at last addressed during the 1990s, as Europe came to the belated recognition that its fast-deteriorating demography had created a fast-developing crisis for its social security and government employee pension programs. |
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