Among the many curious facts about todayââ,¬â"¢s markets is this: The dollar has gone down sharply, but bonds have remained strong.
People who lend in dollars get repaid in dollars. An obvious consequence of a falling dollar is that lenders have to expect to get less back than they originally invested. In the last few weeks, the dollar has lost about 5% against the euro. Yet, the 91-day T-bill lending rate is only about 4.90%. Go figure. Lenders expected only 4.9% on their money - for a full year. And in a few weeks, theyââ,¬â"¢ve lost more than that, in international terms. Whatââ,¬â"¢s more, they still have to pay taxes on the nominal gains...and still have to suffer the effects of domestic dollar inflation.
What are they thinking? Are they thinking at all?
Currency fluctuations come and go, of course. But so do currencies themselves. Yet bond investors seem to be betting that the dollar is eternal; and they find themselves trapped between two paradoxical trends. On the one hand, the U.S. economy is deteriorating.
The inevitable effects of weakness in the housing sector are working their way through the entire economy...like termites through soft wood. Sales are going down; prices are falling; inventories are rising. Fewer people are being hired to pound nails, or grind down granite for kitchen countertops. Fewer people are taking up careers in real estate. And the feds are nosing around a sub-prime mortgage industry; if they want to be ready with some show trials when the business blows up.
Manufacturing is going down too, unexpectedly. Gasoline prices are going up. And Wal-Mart tells us that consumers are not reaching into their pockets with the same sans souci as they once did.
This economic weakness could be expected to lead to lower bond yields - which would mean higher bond prices. Bernanke and Paulson are talking about fighting inflation - suggesting that that the Fed might raise rates. Our guess is that they are just talking, in order to try to hold up the dollar. The real danger for the U.S. economy is not that it is likely to ââ,¬Ëœoverheatââ,¬â"¢ and need higher rates to fight inflation. The real danger is that it is likely to cool off...and ice over. The Fed is not likely to risk raising rates with so many people trying to sell so many houses. It is more likely that they will cut them - which would cause bonds to go up.
On the other hand, the foreign currency markets are telling us that the dollar is vulnerable. It could be re-rated at a level considerably lower than it is today. Currently, it takes $1.32 to buy a euro. It could easily take $1.50. Likewise, the price of gold is $650. It could just as well be $750. Either way, a bond investor has to start asking himself questions: ââ,¬Ëœwhat if Iââ,¬â"¢m right about the economy, but the dollar still loses another 10% on the foreign currency markets?ââ,¬â"¢
And now imagine that you are in charge of your countryââ,¬â"¢s foreign currency reserves...in China, Russia, or Japan. Yes, you can put your money in 30-year U.S. government bonds, guaranteed by the worldââ,¬â"¢s only superpower and denominated in the worldââ,¬â"¢s reserve currency. No one will fault you; it seems like the prudent thing to do. After all, Americans are your best customers. Buying U.S. government bonds is, effectively, lending to your customers. That way, theyââ,¬â"¢ll have the money to continue buying your stuff.
But wait...what if the dollar does go to $1.50 per euro? Imagine that you have $500,000,000,000 in your vault. That would be a loss of about $75 billion. Wouldnââ,¬â"¢t it make sense to hedge it a little? Reduce your dollar holdings $400,000,000,000 - at least?
As the dollar falls, it makes more and more sense for investors to hedge against it - especially foreign central banks. And when they turn their backs on the dollar, it puts the whole ââ,¬Ëœnew imperial cycleââ,¬â"¢ in jeopardy.
Here at The Daily Reckoning, we have been as perplexed as bond investors. We saw the weakness in the U.S. economy...we guessed that it would be good for bonds...and yet, we have been reluctant to buy bonds, because it seemed to us that yields were too low to justify the risks - the stability of the U.S. dollar being the major one.
What to do? Our advice it to hedge against the dollar - by buying gold or foreign currencies - and to avoid U.S. dollar-based stocks and bonds until they offer good value again.
*** Everyone gains from globalization...at least in theory.
Some gain more than others. And there is the rub. Most people are not really interested in getting richer - not in theory. Being richer means nothing to them. It is too abstract. It is like eating. Once you have enough calories...you canââ,¬â"¢t really improve your quality of life by eating more. All you can do is improve your diet slightly...maybe by being more selective about what you eat.
But just because a food is more expensive doesnââ,¬â"¢t make it more satisfying to your stomach. That is, youââ,¬â"¢re not likely to appreciate foie gras any more than you do Kelloggââ,¬â"¢s corn flakes - except that the foie gras might appeal to your vanity. It makes you feel better about yourself; because it proves you are capable of appreciating fine food...and you are able to afford it.
Likewise, if you have $100,000 in the bank...or $1,000,000...what difference does it really make? In either case are you unlikely to go hungry or homeless. It only matters because it affects your IDEA of yourself...your amour proper...and your station in life. In other words, it plays on your vanity and your aesthetic sense of yourself and your surroundings.
These considerations are not absolute. They are relative. Your vanity is flattered not by getting richer...but merely by getting richer than the people around you. Nor do you get much pleasure in living in a better house; instead, the pleasure comes from living in a better house than your friends, family and neighbors.
So even though everyone - again, at least in theory - is better off if the worldââ,¬â"¢s people were able to trade freely with one another, that doesnââ,¬â"¢t mean that everyone is going to like the results. People donââ,¬â"¢t like to see others getting richer faster they are - even if they are all prospering. Theyââ,¬â"¢ll quickly jump to the conclusion that others are getting rich - AT THEIR EXPENSE.
The next thing you know, some blowhard in Congress will be urging tariffs, fair trade, and sanctions.
We know that Asia is a big winner from globalization. Factories are being built in every Middlesex, village and town. Real wages in China and India are doubling every ten years - or less. Consumption of meat-based proteins is increasing quickly. Apartment buildings and office are springing up overnight. Output is soaring. Coffers of central banks...and private accounts...bulge with foreign earnings.
Last week, we read that Europe is a winner from globalization, too. Europe sells luxury products to Asia and the rest of the world. Perfumes, handbags, chocolates, watches, fashions, jewelry - rich Asians canââ,¬â"¢t get enough of the stuff. Europeans also manufacture much of the worldââ,¬â"¢s state-of-the-art tools and machinery. Swiss and German toolmakers are renown throughout the globe. And they make planes, and trains, and automobiles, and subway systems, and pharmaceuticals. Altogether, Europe enjoys a trade surplus with the rest of the world, and a heavy surplus with Asia.
That leaves America. U.S. corporations are extremely active on the world stage...but more and more of what they sell is produced in Asia. From a trade standpoint, the United States is the biggest loser in the world. Its deficit surpasses any other nation...and surpasses even what economists thought possible. Of course, the trade deficit is not the whole story. U.S. companies are still very profitable...and many of them are figuring out how to get along in the world marketplace. They employ Asians to cut costs...and sell to Europeans to boost profits. And their owners - capitalists in the United States and abroad - are happy to reap the profits.
But what about the average lumpen in the U.S. of A? Globalization may make him marginally richer (he is able to buy more stuff at Wal-Mart with less money). Still, his wages havenââ,¬â"¢t really gone up in 30 years...and yes, he got a little carried away in the last great upswing in the credit cycle. Now, he owes more money than ever to more people than ever - including quite a few foreigners.
His leaders told him the new globalized economy would make him rich. Wasnââ,¬â"¢t he an American, after all - a citizen in the worldââ,¬â"¢s most dynamic, most free and most competitive economy? How come he is having such a hard time making ends meet? He is likely to wonder.
Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.