Friday, September 25, 2009

The U.S. Dollar, and the Global Political Economy.

Many economic commentators have theorized that the U.S. dollar is set to see a precipitous decline, and quite possibly lose its reserve currency status as other economic rivals such as China and France call for a replacement currency to replace the dollar as the global reserve currency. Gold Bugs have been predicting the dollar's decline for many years, and believe gold is at least one way protect yourself. There is also a view that is more dominant, as expressed in the reporting of the Wall Street Journal, though clearly, the opinion of the economists polled by the business press, is split 50/50 on the inflation debate. As far as commentators go, in my opinion, at least 5% of those who believe in the coming collapse in the dollar were educated on the matter by Ron Paul, and by extension, the Paul campaign's economic advisor Peter Schiff.

2 Dire inflationary warnings relating to Schiff: One, and Two.

I think the view that Inflation is a threat is misguided, and that Deflation is still in the cards in the short term. I will avoid the broad social explanation for what I generally refer to as "the great depression II" or the "great depression 2.0" for another article, and clearly lay out what I think is happening in finance.

For starters, let's look at the type of inflation/dollar issue that the Schiff/Paul campaign brought
to public attention in the 2008 presidential campaign. There clearly was what we can describe as Asset Inflation or, inflation in the price of assets, such as Copper, Gold, Oil, and other commodities. But my question is were these commodity prices driven up by real meaningful demand and consumption, or were they driven up by the perception of demand by players/investors/commentator propagandists on CNBC?

If you use a K-Winter framework, you may find it useful to compare the asset inflation of the late 1920s (against stocks) to the asset inflation of the 2000s.... (houses, equities, and everything else mentioned above).

But outside of the final run up of energy costs in 2007-2008, Inflation has not been a concern at the supermarket..or software, or TVs, computers, etc... This is NOT the 1970s, this isn't prices rising 10% or so in 1979 (even excluding energy at that time--which was a major driver of price rises).

My argument for what is happening in the global economy can be broken down, roughly, into categories.

1. Falling rate of profitability for investors. Investors DRIVE the private economy and control most of the valuable space in global society. As a result, if this group, and it's a small group percentage wise, makes the decision that it is unable to invest its money, then the economy slows down as the rate investment slows down. Think of this as a standoff. Capitalists want to invest, but they can only invest if they perceive possible profitable investment opportunities. Conceptual workers (or as Mike Albert over at Z Magazine, likes to call them), the "coordinator class" want work, and those in the working class want employment. Yet nobody gets what they want because the economy as a game, has rules, and even if all parties COULD agree on a desirable outcome, unless the rules change, outcomes do not change.

Under normal boom/bust conditions. Capital investment into new sectors creates high profits early in the lifespan of the investment--and then falls over time. This creates employment, generally higher wages and higher employment in any given sector early on, and then falls over time as capital re-investment meets competition, and machines replace workers, and productivity rises. In classical economic theory, labor mobility was supposed to keep wages high, as leverage against capital--but in practice, capital is far more mobile than labor. (think of investing in Brazil from your online trading account). And depending on the politics of a country and time, wages can easily be politically slammed to rock bottom, enriching investor and to a lesser extent, coordinator class types in the process.

In the U.S. Wages were politically boosted in value until the politics of the country changed in the late 1970s. Under the rightward shift that occurred during the Carter/Volcker/Reagan period (2 presidents and a fed chair. Incidentally, Paul Volcker has lived long enough to become famous both as the 'Inflation killer' of the 1970s early 80s, AND as an adviser to current president Barack Obama) wages have been steadily lowered, and returns on capital investments shot this steady drop in the value of labor continued for the next 3 decades, it's my assessment that rising credit took the place of income when it came to consumer spending.

In the short run (1980-1992) profits rose, wages fell, government spending that boosted wages fell, and government spending that boosted profits rose. The amount of federal spending was roughly the same in 1988 as it was in 1980, yet wages continued to fall. A corporate and education propaganda shift occurred in the early 90s, which emphasized education as the road out of poverty (the politics of claiming there is light around the corner, at the end of the tunnel seems to be a time honored tradition for keeping the rabble at bay), and future members of the coordinator class were encouraged to develop the skills needed to get better high paying jobs in the future. But most of these jobs have never materialized, at least not to an extent great enough to pull enough people out of unemployment. So at least in the U.S. coordinator class leverage against capital is weak, and weak leverage means low pay and underemployment.

As for the working class, things appear much worse. Wages peaked for ordinary workers in the early 1970s. Factory jobs were sent overseas. They were not sent overseas for any other reason than the fact that the wages paid in manufacturing were higher. Why were wages higher? The collective bargaining regime that lasted roughly from the mid 1930s until the late 70s (Broken by the Carter/Volcker/Reagan crew). The replacement capital has come in the form of service industry work. This work does not pay well. It does not offer benefits, pensions, security, or dignity. Yet the trend will continue to grow. If there is employment to be found, it will be in the service sector--again, low pay, no benefits, no security, etc..

From 1992 until the present, this trend continued. Long term decline in manufacturing, long term increase in the size of the service sector, long term increase in credit, and long term decrease in income for the middle class (i.e. the union class). Starting in the 2000s, the tech bubble came, which brought a flirtation with highly paid tech jobs (only to see the leverage blown out after a couple of years) for coordinator class types. As this bubble burst, the economy nearly imploded, and deflation was regarded as a potential threat by then Fed Chair Alan Greenspan. Rates were lowered, and one final asset bubble push was created. The housing bubble, which I will not delve into here, along with the previously mentioned commodities and oil bubble all share a common theme: wealth is created through the process of a pyramid scheme. the value is driven up the more people play the game. And since it was the only game in town (compared to working the deli counter) and since there was a flood of incentives (easy to get loans, high amounts of credit, etc..) to invest, investors were able to create artificially high price valuations for these things. Of course, the actual income from actual work and wages did not change or went down...and when the end of the mania came, the blame was focused heavily on the details of the housing about missing the forest for the trees.

Reason # 2. The U.S. dollar's role both as the currency of last resort--but also as a carry trade currency: The carry trade is simply the borrowing (selling) out of one currency (in my view, U.S. Dollars) , and then parking it in a higher yielding currency. This can be parked not simply in bonds of a higher yield but in the aforementioned commodities and stocks. This is what I think has occurred to a slow extent from 2000-2008, and to a greater extent from 2008-2009 (after the equity crash of 2008).

3. The collapse in equities and commodities, despite the kitchen sink of Quantitative Easing being thrown at the crisis will lead to a medium term rise in the dollar because I suspect that our major asset classes (commodities and equities) have been financed out of the U.S. dollar, and the Japanese Yen. I cannot predict if the dollar will rise against the Yen if my scenario unfolds, but I think clearly it will gain ground against the Euro, pound, and other majors. If and when there is a 2nd decline in the equity markets, especially the kind that is bought on leveraged loans, the sell off of a stock or commodity will be converted into currency--driving UP the demand for dollars.


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