We’ve seen some real wild swings in the dollar recently. That is largely because the ‘safe haven’ trade is coming off around the world. Currency speculators are selling the dollars they bought when it looked like Armageddon was upon us and buying something that may have a better outlook. Also, there is this huge wave of bonds that have to be sold by the Treasury and they will swamp the market. Then the US is likely to enjoy a period of untoward inflation in coming years. So why would anyone be surprised if the dollar went down a bit. The issue is that the dollar has gone up a bit here lately. Part of that might be the dollar got oversold or some other currencies got over-bought or some other technical explanation (can you say Iranian elections?). Part of it could be that the scare that foreign central banks would stop holding dollars as their principle reserve currency isn’t going to pan out after all.
So many currents back and forth makes us almost seasick thinking about it, or maybe that’s just our dollar hedge impacting us.
For the time being, at least through this recovery and into the next up-cycle, the dollar is the world’s primary reserve currency and that won’t change right away. Why the dollar is the world’s primary reserve currency dates from the Bretton Woods conference after World War II. The idea was that the US dollar was the only currency at that time that was in broad circulation. The US during the war had put many dollars in the hands of our allies. The currencies of the vanquished Axis powers were worthless. The British pound was struggling under the weight of its pre-war and post-war commitments. The dollar was really the only alternative. So, the folks at Bretton Woods agreed that the dollar would maintain convertibility into gold at $35 dollars an ounce (yes, $35 a ounce) and that all other currencies would tie themselves to dollars at a fixed exchange rate. So, the dollar was as good as gold, only the Treasury could print as much gold as they wanted to.
That all worked reasonably well until the inflation of the late 60’s got everybody all worked up. Nixon then terminated dollar convertibility into gold in 1971 so that multi-national demands wouldn’t hamper his efforts to manage the US economy. But, despite the lack of convertibility into gold, dollars were still the de facto world currency.
So many dollars were in circulation and no other currency was even remotely large enough to handle the volume of transactions that the dollar continued to be the primary reserve currency for most nations around the world. That system (or rather lack of system – often referred to as Bretton Woods II (or the emperor has no clothes)) remains in force today.
So, the big deal these days is coming up with a system that doesn’t use only dollars for much of the central bank currency swapping that goes on. The first proposal would be to not have a system at all but to use multiple currencies instead of just dollars. So, instead of having all your eggs in the dollar basket, you’d have most of your reserves in dollars but also have some Euros, some Yen, some Sterling, some Swiss Francs, some Yuan, and maybe some Rubles. If you looked at the line-up today, it might be 70% dollars, maybe 15% Euros, maybe 5% Yen, then a few Pounds, a few Francs, a couple Yuan and maybe one Ruble. But, in the future the share of dollars would be down to below 50% and then we have to start worrying about the future of the buck.
Getting from dollar supremacy to dollar commonality will probably be painful, but nothing like the discipline that awaits when the dollar is just another currency. Imagine if you can what would happen to the dollar exchange rate if we weren’t partners with all these other nations. The stupidity and arrogance that we display now would be punished by having our currency driven into the dirt. Welcome to Argentina north.
Good News
The leading economic indicators were up by 1.2% in May from April. That change was largely driven by stock prices, but six other indicators joined stocks in rising. Only three indicators fell in the month. We now have put back-to-back months of gains together for the first time in over a year.
Economic Numbers
producer prices were reported last Tuesday and they were higher by 0.2%, lead by energy prices. The core version of the index, which excludes food and fuel costs, fell by 0.1%. This was far less than was expected by economists, who forecast a gain of 0.5% for the index and 0.1% for the core. You think this might lead to renewed deflation scares? Over the past year, producer prices have fallen 5.5% while the core index has risen 3%.
Consumer prices were also reported a day later and they were up 0.1% both at the headline and core level. The huge increase in gasoline prices was supposedly off-set by declines in food prices among other things. Oh well, no sense arguing about it, if they want to pull an Ahmadinejad on us so be it. Over the past year, US consumer inflation was down 1.3%. That’s deflation folks, the scourge of growing economies everywhere.
At the same time, Euro-zone inflation was up 0.1% in May and was unchanged from May 2008. British inflation was up 0.6% for May and a 2.2% year-over-year rise.
Housing starts were up, which doesn’t take much given where they are. Last month, multi-family construction rose enough to make the whole industry rise 17%. Multi-family rose 62%, but it is a volatile number. They count all the units in a phase of development when they start that phase, so it could have been a handful of complexes all begun at the same time. Single family starts rose 7.5%.
Industrial production was lower by 1.1% in May from April. Industrial production is down 13.4% over the last year. This is the worst drop since 1946 during the de-mobilization from WWII. Capacity utilization of the nation’s factories, mines and mills was at a record low of 65%. That means that we can have quite a bit of growth before we have to build a new factory.
Weekly Stuff
Foreign markets were sent reeling by the brouhaha in Iran. The ‘supposedly’ stolen election sent hundreds of thousands into the streets in protest. This raises the risk of revolution (or would it be counter-revolution?) in Iran and also a more unstable Middle East (if that’s possible). You saw the impact on the dollar (a reasonably reliable indicator of the world’s risk outlook) when it popped a week ago last Friday as the polls opened in Iran. The dollar moved higher on Monday as violence in Tehran was broadcast to the world. The dollar then started settling back on Wednesday as Iran seemed to cool-off a little and as the threat to the sitting government of the mullahs and the radical militants seems to be weathering the storm.
Losses seemed to radiate out from Iran as the markets in nearby countries were down a lot more than more distant bourses. But, nearly everyone was down (the lone exception being China) between 2% and 4% among the leading emerging and the developed markets alike. Foreign bond markets had a dollar headwind but a general flight to quality that aided the markets in local currency terms. Again there were exceptions to this trend.
Well, it isn’t Glass-Steagall, but the new Obama administration plan to reorganize the financial industry was announced last week. The changes seem to fall far short of the worst fears of Wall Street and the highest expectations of consumer groups. It will likely be opposed by many Republicans in Congress (the opposite of progress) for being too expansive and opposed by many Democrats in Congress (the opposite of progress) for being too limited. You can’t please everyone it seems. Since there are so many people against it, it will probably undergo several modifications and adjustments which means we may get a better result than this when all is said and done. The remaining question is what defines a better result? That will depend on whom you ask.
US stocks generally sank due to fears of the Iranian election tumult and the rest of the world’s reaction to it and then never really got back up again. On the bright side, we were lower on Wednesday than we were on Friday. Besides the lack of momentum lately, US stocks face another earnings cycle beginning in just a couple of weeks and have moved substantially in recent months to alleviate the deep oversold we reached in early March. Wiggles up and down around this level would be a benign result of this much movement. Called consolidation by technicians, this thrashing about is a regular feature of market activity. As the bard reported “much sound and fury, signifying nothing” (great stock analyst that guy).
The major indexes were down 2% plus, except the NASDAQ, which was down ‘only’ 1.7%. We’re making up for that this morning. In a new segment that is written mostly for your pundit’s benefit to remind us that not all sectors are created equal, healthcare was the best performing stock sector last week, while energy was the worst.
Look for some serious window dressing between now and the end of the month as many fund managers who missed most of this rally strive to at least look like they’re fully invested in some of the winning areas. This might impact technology shares, financials and healthcare as these areas led the early advance and can be justified as still good value even after the advance.
US bonds were generally ahead last week, except for the high yield space, which often moves more with equities than other bonds. Treasury bonds, other high grade sectors like GNMAs and high grade corporates and munis were generally higher.
We saw more weakness in real estate last week along with the stock market. Declines in US REIT prices were on the order of 5% to 8% while foreign real estate securities were down far less. Higher interest rates in recent weeks are part of the problem as is the upcoming reporting season. Most analysts expect fairly poor results from most real estate related companies. The environment is not conducive to very profitable operating results, but at current prices, discounted from reduced property values, real estate securities are still quite attractive.
Commodities had a tough week lead by energy prices. Many segments of the commodity arena participated in the declines. Industrial metals and precious metals were lower due to concerns that a huge inflation wave may not materialize as quickly as hoped for. Many agricultural commodities were lower as well.
Weidersehen
Hopefully all the dads out there had an enjoyable weekend and a pleasant Father’s Day. According to the internet, Father’s Day almost didn’t get off the ground when first proposed in the US. Many squawked that the calendar would get filled with other odd holidays like Secretary’s Day, Boss’s Day, Grandparent’s Day, how prescient. While everyone took to Mother’s Day, Father’s Day had a hard time getting up and going. It was largely through the efforts of the Associated Men’s Wear Retailers that the day was judiciously pushed and pushed until it finally got Dads on the calendar. Oh well, once again we are in debt to those brave people who have gone before us pushing for phony holidays. At least this is a phony holiday that half of your pundits can benefit from.
Karl Schroeder
Schroeder Financial Services, Inc.
480-895-0611