Today’s letter might take a bit of twist from the norm, so bear with me a bit. First lets ask the simple question. Just what exactly is this letter supposed to do? In it’s basic form it’s purpose is to help educate people to the stark realities of our global economic situation, and then with a little luck, help those same people make decisions that can bolster their personal wealth. That’s the purpose of the letter. Yes there’s another angle to it, lets call it the “big gimmick”. See, we also sell a membership to what we call our “Insiders Club”. If people can’t get exactly what they need to navigate the market via the letter, we do hope they join up and watch in fairly real time what we do with our own money on a day to day basis. The cost is 159.95 per year. We priced it to the level that virtually anyone can afford it, and we think it’s a pretty good value. Our theory is that if we put out really great info in the free product, and it helps people, the law of reciprocity says people will help us in return. It’s pretty simple. Believe it or not we have many subscribers that pay each year that don’t need any help in their market activity at all, they subscribe as a way to say thanks for maybe something we showed them in a letter years ago that helped them. It’s quite remarkable really.

Naturally the free letter has 4 times the subscription rate as the membership area. By any level of marketing you use to evaluate something, a product for “free” will be taken up considerably more times than one where people have to dig in their pocket. That’s just human nature. I do want to state however, that I think we put so much good useful content in these free letters, that many find it sufficient in helping them plan their decision making. If that’s you, great, I’m glad we could help.

Because the letter is designed to talk to the “masses”, I try and keep high brow esoteric talk about economic theory to a minimum. I’m not trying to “dumb it down”, I just have a feeling that people get a lot more impact out of things if you talk to them on a level resembling having a conversation, versus some “white paper” expose with a lot of facts, figures and hyperbole that gets boring quick. Today I want to try and merge the two a bit. Here’s the story.

I am not the only thing people read. People read books, have subscriptions to other services, etc. It’s pretty common for someone to send an article or a book and ask my view of the authors stance. I have no problem with that, we are all products of what we see and hear, so I’m always willing to have an open mind. Granted I may bite back viciously against what the fellow says, but I will certainly entertain his view. Of course there are times when my eyes are opened to something I hadn’t thought about, and that makes us all wiser in the end. So, what prompts todays banter? I was forwarded an excerpt from a book, that had also been forwarded to another market observer for his opinion on the theory. Then I was asked to comment. When I started my comment back, I had no idea I’d decide to include the discussion for today’s letter, but after review, I think it’s worthwhile for all of you.  So, follow along and you’ll see where this goes. The following is a portion of the excerpt and the book credits:

EXCERPTS FROM: “The End of Influence: What Happens When Other Countries Have the Money.” By:Stephen S. Cohen–Professor in the Graduate School anad co-director of BRIE (the Berkeley Roundtable on the International Economy) at the University of California, Berkeley; Senior Fellow at the Center for American Progress) and Bradford DeLong–Professor of economics at the University of California, Berkeley and research associate at the National Bureau of Economic Research.Basic Books. New York; 2010.

THE ONCE AND FUTURE DOLLAR

And what of the dollar? Could a sudden sharp decline in the value of the dollar destroy foreign government wealth holdings and make them a curiosity and not a problem. (Back in 1985, remember, the fear was that Japan was going to own America and then Japan’s accumulated and capitalized export surpluses largely vanished between the Plaza Hotel and the Louvre as the dollar fell in value.) Alternatively, can foreign debts owed by America lead us to a dollar crash that cripples the U.S. economy in a manner analogous to the Mexican Crisis of 1994-1995, the East-Asian crisis of 1997-1998, or the Argentine crisis of 2001-2003–only marvelously bigger? It is likely that the answers to these questions are no and no.

For at least an entire decade, economists have been anticipating a relatively sharp fall in the dollar down to balanced trade fundamentals. Yet, rich private foreigners value having large chunks of their money in the United States as a form of political risk insurance. They are continuing to increase the size of that chunk they wish to hold in America. Foreign governments continue to increase their holdings of dollar-denominated securities to make sure that they can keep exporting to the United States at a pace that allows for export-led growth and thus produces domestic social peace.  And the role of the dollar as the key currency of the international monetary system creates a large demand to hold dollars as reserve stores of wealth–the “exorbitant privilege” of which Charles de Gaulle complained two generations ago. As long as these three factors keep operating, the value of the dollar will remain relatively high. And these three factors have already shown remarkable persistence. Their end is likely to be far off, and unlikely to be sudden.

Moreover, the fact that the United States has borrowed and its debt is denominated in its own currency, dollars, while Mexico, East Asia, and Argentina borrowed in a foreign currency, also dollars, makes a world of difference. Huge debt owed to foreign currencies is severely disciplined, and you have to painfully earn the currency. Huge debt in your own currency is different; the United States can always create more dollars and its value is everyone’s problem.

The maintenance of the dollar at a value stable enough so that its changes do not disrupt the finances of dollar-holding foreign governments is now a common aim of world governments. If they can keep the dollar from losing value rapidly, they will do so. Other countries lose a fortune when the dollar falls: their holdings of dollar-denominated securities are now worth much less in the coin that has meaning to them. As the value of the dollar falls, it makes room for the dollar prices at which the United States sells its exports to rise, while the dollar debts of America owes stay the same. Consequently, U.S. foreign debt becomes less and not more burdensome as the dollar falls in value. It means, as Nixon’s Treasury Secretary John Connally–a man whom his deputy Paul Volcker said was strongly in favor of taking bold action bud did not care much which particular actions he took as long as it was bold–quipped to his foreign counterparts that instability in the dollar is “our currency, but your problem.”

A sharp fall in the value of the dollar means that the processes we examine in this book are considerably accelerated. When the dollar is worth less, Americans, because they hold dollars, are poorer, and foreigners richer. The pace at which America loses its various forms of soft-power influence accelerated. And the speed at which pieces of America are bought up by others is more rapid the lower the value of the dollar, because a 50 percent lower value of the dollars is essentially a half-off asset sale. The resources of foreigners continue to grow at their previous rate, but foreigners will get more bang for their Euros when the investors more their money into the United States when the dollar is low.
In fact, as long as the dollar remains the centerpiece of the world economy, there is a strong case that successful global economic growth requires an increase in U.S. indebtedness to the rest of the world–and the U.S. international debt is no problem at all, but rather, as Alexander Hamilton would have said were he alive today in his old corner office at the Treasury Department, a global blessing. Just as a growing demand for cash produced by a rush to safety in financial panics requires a central bank to act as a lender of last resort to head off universal bankruptcy, so a growing demand for dollars by foreign governments and investors to expand world trade requires that the United States act as importer of last resort–and let its trade deficit rise (and its export and import-competing manufacturing sector shrink)–to create the global liquidity.

This piece was sent to a gentleman for comment. This was his reaction.

“People have been talking about the demise of the U.S. dollar for more than three decades, and yet the U.S. dollar index is virtually identical to where it had been in October 1978.  Perhaps in some theoretical world, where another country becomes clearly superior to the U.S. in terms of total GDP and consistent GDP growth–maybe China and/or India and/or Brazil 100 or 200 years from now–the U.S. dollar could become significantly lower.  However, along with the points that the article below highlights in an intelligent fashion, such changes will not happen quickly.  When such changes do occur, they will tend to be strongest during eras of prosperity when there will be the least dislocation from a major currency shift. In our lifetimes at least, the U.S. dollar will remain the supreme world reserve currency”

Both of these pieces were forwarded to me for comment and reply. Although I might ramble a bit here and there, you’ll see some basic premise/themes that I want to convey:

As you may suspect, I have a much different view than the fine people that wrote that passage, and that of Mr. “X”‘s response.

“Because it was, it must be” is indeed the single biggest fallacy ever to befall man.

In the book’s own words:
In fact, as long as the dollar remains the centerpiece of the world economy, there is a strong case that successful global economic growth requires an increase in U.S. indebtedness to the rest of the world–and the U.S. international debt is no problem at all, but rather, as Alexander Hamilton would have said were he alive today in his old corner office at the Treasury Department, a global blessing

Now please take note of the first 14 words. “as long as”.  Really? Well as long as I don’t get cancer, I can safely presume I won’t die from it. Is it not true then that If I do get cancer, I may die of it? I believe that would be an accurate assumption. I will get back to that, but first lets dissect it by examining the reply from Mr. X.

People have been talking about the demise of the U.S. dollar for more than three decades, and yet the U.S. dollar index is virtually identical to where it had been in October 1978

While this is certainly true since the dollar is worth no more or no less than in comparison to the basket against which it is compared, it removes the rather large question concerning the value of said monies. In terms of true buying power, we have significant issue. Whilst the dollar index may indeed state a unitary comparison rate to the 70′s, what is the velocity/magnitude of economic impact from the utilization of that particular dollar? If indeed one unit of currency continued to secure the same level (i.e. amount) of service or product that it did in decades past, one could postulate that “as it was, it still is”.  Unfortunately, monetary values as perceived via comparison of varied currencies, all of which are fiat, and manipulated in nature, results in equations that prove out quite nicely in an economists mathematics, while true economic activity/impact is significantly different in nature.

While the economists dollar of 1978 still occupies a space equal to the index basket thusly compared, the true monetary unit itself completes a significantly smaller transaction. Interestingly however, the impact of any one particular unit is not equal in response as per volume/quantity depending on geographical and/or socioeconomic conditions. Hence values of any one particular unit will vary in the intensity of returns.  (i.e. a “dollar” whether equated in yuan/peso/real etc,  will usually buy more product/service in Southeast Asia, than it will in NYC – US)  With that in perspective, not only are we dealing with a situation where the 1978 unit purchases some magnitude of percentage “less” today than it did in 1978, the velocity/impact of that unit varies considerably upon utilization.

Many has been the argument that a “floating” currency reflects the intelligence and collective wisdom of all known knowledge, thus the pricing between currencies is always correct at any particular moment. Whilst the discrepancies between perceived value create significant opportunity for specialized traders to capitalize on that via arbitrage, (i.e. playing the spreads, and carry trades) the end result in a world that is ever more connected via trade, are  inequalities not easily dismissed. In the absence of a “standard”, history shows us that arbitrage “fiat” currency has a rather dismal track record of stability and ultimately longevity. Please take note that we have only been a completely floating currency since 1971, when the last loose tie to gold was severed.

In the case of economic impact, or the so called “ripple effect”, one dollar unit “spent” in 1978 could be fractioned considerably more times than the dollar of 2009. In simpler terms, If one dollar unit was used to buy something like a collection of gum, it’s conceivable that five different companies could have enjoyed the profits of a sale because you purchased five packs of gum. This would figure into the various companies plans to hire and possibly expand production.  In 2009 its possible that our lonely dollar unit only buys 1, 2 or no packs of gum. Thus instead of 5 companies reaping the benefit of a sale and further promoting their business, only one or two can. The difference is NOT insignificant. The velocity of money, better described maybe as how often it changes hands, tends to be quite retarded when inflation rears it’s ugly head. If one were to use the Inflation tool provided by our own Government found here at http://data.bls.gov/cgi-bin/cpicalc.pl  we see that it now takes 5.53 to purchase in 2009, what one dollar purchased in 1970.

Now let’s consider this for a moment. It would take 1.94 in 1970 to purchase for a dollar unit, what 1.00 purchased in 1920. In the span of 50 years our currency unit remained fairly stable, as it was still loosely tied to a “standard”, but still lost 94% of it’s buying power.  Then we see that with the abolishment of the gold standard, in the next 40 years from 1970 to 2010 official dollar devaluation rose by an incredible 185%. Given ten more years to make the time periods equal, (50 years and 50 years) and we should see well over a 200% devaluation from just 1970.  Since our Dollar Index “remains at levels identical to 1978″ but the purchasing power, impact, and velocity of money has deteriorated by hundreds of percent, one must ask the simple question. What exactly is the “index” measuring? Given the incredible rate of acceleration in the devaluation of our money based on true exchange of dollars for labor/services/products, are we to assume because it was, it will always be? I believe the Romans considered that a time or two.

Now let’s take a quick peek at the book’s theorem that “In fact, as long as the dollar remains the centerpiece of the world economy, there is a strong case that successful global economic growth requires an increase in U.S. indebtedness to the rest of the world-, -so a growing demand for dollars by foreign governments and investors to expand world trade requires that the United States act as importer of last resort–and let its trade deficit rise (and its export and import-competing manufacturing sector shrink)–to create the global liquidity.”

The opening sentence “as long as” strikes me peculiar. As long as we didn’t lose the war we won. As long as I didn’t break my leg I could run. As long as i pass my tests I will not fail. ???? Just why exactly should the dollar remain the centerpiece of the world economy? Because it was, it shall be? Are not our bills larger than our income? Do we not have to borrow to extremes, to simply stay afloat? But more importantly, IS THIS THE CONDITION WE WERE IN 50 YEARS AGO?  Actually no. Something “changed”. We were the worlds biggest CREDITOR in 1978. Today we are the worlds largest DEBTOR. For some unknown quirk of human nature, most economists, and government officials simply dismiss this change as if it means nothing. Well of course it means “something” it means we have to create money via borrowing and instantaneously more debt, just to service the debt we’ve built already.  They tend to dismiss that fact as insignificant. I will now present a fact that is not only insignificant, it is absolute, real and will indeed be reckoned with. The US is mathematically incapable of paying off it’s debts now.

Just this week they voted to increase the debt ceiling to over 14 trillion dollars. Each new dollar that comes into existence comes with an interest due note attached to it. The Treasury borrows it’s circulation currency from the Federal Reserve. Just the interest on the debt which is now in the hundreds of billions is the fourth biggest budget line on our balance sheet after defense, medicare and social security. Now consider that almost 51% of our interest goes to foreign holders of our debt, and one might pause to wonder. “how long can this go on?”

The United States will always be an important consumer of goods, we have no choice, we don’t make them any more. But to equate that with the statement that it’s fine to run import/export deficits and owe the world ever bigger debts as being just fine is something interesting to say the least. If you hadn’t figured out where I was going with all this, well here’s the punch line. 99% of our problems have come about after the abandoning of a loose gold standard. We have had an experiment with a completely fiat currency since 71. We saw a monster recession in the 80′s, a stock market tech bubble in the 90′s. We saw the oughts bring us two monster market melt downs, a credit binge of unprecidented levels, a housing bubble and crash, a banking fiasco so criminal they should be shuttered and a national debt/deficit that is mathematically impossible to  balance.  We saw real incomes fall the most in our history, oil reach 150 dollars, and foreclosures in the millions. To think “because it was, it will be” seems infantile to me. That denotes going along as it is, as if any of this is sustainable.

Just this week, a lot of our market’s wicked movement was in response to the PIGS, which are Portugal Ireland, Greece and Spain. Why? Greece has been an economic nightmare for half a century, while Portugal, Ireland and Spain hopped on the US bandwagon of insane loans to people with no ablility to pay them back. They are all mired in nightmare debts, and are looking to the EU and the leadership out of Germany and France to “help them out”. Then we have the “STUPID” nations. That’s Spain Turkey Ukraine Portugal, Ireland (exchange Italy any time) and Dubia. How soon we forgot Dubai eh? Another nation who gorged on an orgy of credit/debt and blew up. Or how about North Korea, when just in November they devalued their currency making their subjects turn in 100 of their “dollars” for 1 in return. Or Zimbabwe defaulting on yet another debt as their inflation rate hit 1.5 billion percent. How about Japan and their lost decades? How about Great Britain, another country only able to avoid the “banana republic” moniker because they have no bananas.

When the US was indeed the economic power house of the world, we had a manufacturing base envied by the world, and a dollar with a decent root in gold. There were surpluses, one income families, and doctors came to your house. Now there’s no gold standard, you can’t afford a doctor, they shipped the plant to China, and you have to put your wife and child to work to make ends meet. Call me silly but from up here in the cheap seats, the US  dollar looks like a bug looking for a windshield. In fact, in one of the more disgusting tragic comedies, the only reason the dollar can show any strength at all versus other currencies is that their countries are in just as bad a shape as ours, but they never had the privilege of having their currency declared the “reserve” currency. That’s virtually all that separates us. Welcome fellow Zimbabwean.

The answer is and will be, a return to some form of standard after this system finishes it’s collapse. The bankers are going for broke because they know the derivative casino games will soon be over, and they are getting all they can get while they can. Our system is busted, our dollar’s worthless, despite what the stupid index displays. Out of the ashes will be a new dollar, backed by a percentage of gold, and true fiscal adherence to some sanity. But that’s in the future, first we have to continue our crash.

Now onto the market.

Do I want to rehash the jobs report? Not really, so let’s just hit the high spots. They say we lost 20K non farm payrolls. Did we? I doubt it.Challenger says 50K+ got laid off, and 480K had to sign up for initial jobless claims last week. That’s on top of the 460 the week before, and the 445 the week before, etc. One has to wonder why almost 2 million folks a month need INITIAL unemployment if we only lost 20K jobs?  In any case, this number will be found to be a bit of a sham when they do their revisions, etc. So, for not let’s just suggest it wasn’t what it appeared.

A much more intruiquing question is “what about that initial reaction?” Wow. We had already fallen from 10723 to 10060 in general market weakness, and then Friday we fell 167 points at one time during the afternoon. Then, as if the calvary had appeared, they poured on the heat and in the last hour took us from down 167 to + a few. Now that was fun wasn’t it?

Now we have to ask all the big questions. Was this just a simple correction in an overall bull trend that was overdue? Was the problems with the PIGS really causing it? What about the dollar’s strength and the carry trade pulling in? Well of course it’s a bit of “all the above”. We are in a period of tremendous confusion. Even well established bulls know the market got way way ahead of itself and needed to come down a bit. But the troubles in Euroland are real, very real. So that weighed on us. You can toss in our revised debt ceiling, Obama’s push to punish the same bankers that got him elected, and a host of other nasties.

Look friends, here’s the deal in a nutshell. We have November elections coming at us this year and the Democrats are going to push forth as much stimulus money as they can possibly push to prop up the economy between now and then. You can’t push trillions in the pipe without something coming out the other end, so there’s going to be better looking economic statistics showing up. Most will make the disastrous decision that the worst is over, the economy is healed and all is going to return to “normal” what ever that is. The truth however is that the second the stimulus is over, the slide lower resumes. I have NO shreds of evidence what so ever that there is enough organic economic growth to continue expansion once the stimulus is exhausted.

So, with that in mind, could we see the market regroup, and push ever higher, threatening the highs we saw at 10.7k? It’s surely possible folks. The only question we had in our mind was simply “how low would the correction go”  before we got that “big ole bounce?” We didn’t know and we still don’t. There’s good reason to think we could test 9600, which wasn’t that awful far away on Friday afternoon. But “they” came in and rescued things. Okay for the people who still think the market is some free moving, completely innocent reflection of investors attitudes, let me ask you all something. Do you really think it was just “random” that we recovered Friday?? DO you? Do you think that at that very instant at about 2.:50 pm, millions of investors around the globe decided “that’s it, the perfect point to stage a 167 point rally” and bought stock? If you believe that, I do have some bridges laying around here I need to get rid of.

“they” rescued the market from a free fall. Whom ever it was, they bought the futures, triggered the buying programs, and that fed on itself to pull off the recovery. We ended the day above DOW 10K so that this weekend everyone could see that number and feel comfortable about leaving their hard earned money in the market. But the question still lingers. Was that “it” and now we can push higher? I tend to think we won’t know that answer until Wednesday folks. Why? Follow me.

With the big reversal, and any news out of the G7 about helping Greece, we could easily tack on another 150 points Monday. But a reversal and a one day spurt higher doesn’t a trend make. Don’t forget, despite the market recovering those 167 points, the market only “gained” 10 points over Thursdays close. It was statistically flat. Yes it might have some momentum over the recovery, but is it sustainable? I think it is and will try and play it to the long side. But I am not going to be even a bit surprised if we’re looking at a one day wonder and we’re back under 10K in a couple days.

My feeling is that we might be entering a period of “lower highs” where the market runs up, say to 10600 and fades off. Then after a big dip another push up and we hit maybe 10450 and rolls down. Then up to 10200 and so on. This rolling pattern and chop could take us right on through the whole year. Could I be nuts and we simply blast over 11K? Sure. There’s soooo  much loose cash sloshing around out there, who’s to say they can’t take 500 billion and go play in the markets? At this point could you even know? They’ve pledged or spent 12 trillion already, they aren’t above using a few hundred billion to “help Americans” balance sheets. ( oh and wall street to by the way!) It’s also possible that because of pushing stimulus money, they can hype earnings to the point the market goes up and over 11K.

Time will indeed tell, but every day I see more and more cards falling in this global house. Maybe we get higher. But I’m siding with no, we’ve seen the highs and we do the rolling chop to lower as the year progresses. I am going to try and lean long into the market Monday and see if this turns into a decent bounce. I won’t feel that great about it until Wed, and by then we’ll know. If it reverses, I’ll be setting out shorts left and right. Let’s see where we are when we post again Wednesday night. Take care and enjoy your Superbowl.

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