Friday, November 13, 2009

Trying to Stop a Niagra Falls of Dollars

First, a few facts. Brazil's GDP is about $2T, South Korea's is about $1.3T and the United States' is about $14.3T. That is, economically, we are more than 4 times the size of Brazil and South Korea combined. Both South Korea and Brazil rely to a great extent on exports to make money, many of them exports to the US. If the Dollar falls, their stuff becomes more expensive and we buy less of it. They'd really like to maintain some minimum exchange rate so they can keep exporting stuff to the US.

Unfortunately, because we're printing and lending and borrowing and otherwise shovelling Dollars into wood chippers as fast as we possible, they cannot hold back a financial Niagra of Dollars.

A 6-month chart of the US Dollar measured against a variety of currencies. The Dollar has fallen 10% in 6 months.

Bloomberg is reporting today that Brazil and South Korea have given up trying to stop the flood.
South Korea Deputy Finance Minister Shin Je Yoon said yesterday the country will leave the level of its currency to market forces after adding about $63 billion to its foreign exchange reserves this year to slow the appreciation of the won ...

Brazil’s real is up 1.6 percent this month, even after imposing a tax in October on foreign stock and bond investments and increasing foreign reserves by $9.5 billion in October in an effort to curb the currency’s appreciation. The real has risen 33 percent this year.
So why is this happening? Well, Bloomberg is claiming that the cause is precisely what Dr. Doom said would cause another big crash. The Fed is holding US interest rates at an unnaturally low level.
Much of the greenback’s decline stems from investors borrowing funds in the U.S., where the target benchmark interest rate is between zero and 0.25 percent. They then invest the proceeds in countries with higher rates and faster growing economies.
Cheap Dollars means low risks for borrowers so they borrow as many Dollars as they can and invest them in foreign countries. As both the exchange rates and the investments rise, they get a compounding effect and make a ton of cash. Note that no goods are actually trading hands, it's all a matter of more cash chasing the same number of investment assets. There is no corresponding economic expansion, it's all based on inflationary policies in the US. This is a bubble.

A 6-month chart of EWZ, a Brazilian index fund that grows both when the Brazilian stock market grows and when the Real appreciates. It's gone up more than 60% in the last 6 months.

That chart shows what's going on in the rest of the world as we borrow and spend like maniacs. Because we're so much larger than Brazil, when we decide to invest there, or when we loan American-sized chunks of money at ridiculously low rates to others who invest there, there's an outsized effect on their markets. Brazil's economy is growing at about 2% while their market has gone bonkers. They're frightened because they can see this is just a Dollar-induced bubble, but there's nothing they can do about it.

Like we care.


Anonymous said...

So mostly you are critical of what is being done. I'd be interested in what you think the ideal group of economic policies are given the current situation and how they would lead the nation to prosperity.

K T Cat said...

Short answer, to be elongated in a post later:

Raise interest rates and protect the dollar. There are zillions of dollars in short term T-bills rolling over every year. If investors throw in the towel on the dollar, you're just a really big Argentina.

Balance the budget and stop borrowing like mad. Running $1T deficits isn't ever going to make things better in any scenario. Running up that debt didn't stop us from getting here, either.

Pay down the debt.

This will mean cutting transfer payments, cutting social security, cutting defense, cutting the minimum wage, cutting everything. It will be a reduction in our standard of living, not prosperity. Prosperity will come once the debt is being paid off.

The big thing to realize is that this reduction in our standard of living is going to happen anyway. The longer you wait, the worse it will be.