Confessions of a consummate dollar hoarder

This post can be taken as part 2 of my post Diary entries of a consummate dollar pegger.

2000 – I am on a mission. The mission is to accumulate as many dollars as I can. The recent financial crisis here in Asia made me realize this. He who has the most dollars is most safe. Funders will leave any country that they think has a shortage of dollars, hence, making the problem worse. The capital flight makes dollars even harder to come by, and makes the country need the dollar even more. I resolve to have enough dollars to pay for my needs. Everything in this world is denominated in US dollars. You need US dollars to pay for everything – oil, diesel, food, precious metals, cotton, all sorts of commodities. Nobody will take my currency because they think it might depreciate. Nobody will take my currency because they think I’m not good for it. But everybody will always take the US dollar because it’s the world’s default currency. They can take it everywhere else too because everybody accepts the US dollar. Hence, I will make myself the biggest holder of the US dollar. I shall never have any shortage of it, and everybody will come to me to borrow it when they need it.

2002 – I am on a roll! I am the world’s biggest net exporter. Everybody pays me in US dollars. I am getting more of it than I know what to do with. But I cannot stop now. It’s like opium- the more dollars I get, the more of it I need. Why? Because I need it to buy the raw materials for my products. I need it to fund my relentless expansion. Most important, I need the jobs that being the world’s biggest exporter creates.

2004 – I now have more dollars than anybody else, except for the Americans themselves. I have more than I will ever need, and yet I get more. Everybody pays in US dollars, and I dare not accept any other currency. And the only way I can continue creating my domestic jobs is to have a continuous export surplus. The only way that will continue is for someone else to continue having a deficit.

For what it’s worth, the Americans are my biggest customers. They spend like there is no tomorrow! They have a deficit, not only with me, but with everybody else in the world it seems. Why do they keep doing that? Don’t they know that having continuously large trade deficits causes their currency value to go down? Why do they keep on consuming? Do they only think of themselves? Why do they not think about my precious dollar hoard? What will happen to its value in the long run? I have to start spending it now before it loses al value. But how do I do that without losing my precious trade surpluses? I don’t want to give Americans the advantage. I want to be the biggest baddest net exporter ever.

And what about the other net exporters to the US? Why do they keep on doing it? Don’t they know that this cannot go on indefinitely? If they all accumulate US dollars, then I get no advantage with my dollar hoardings. If everybody has US dollars, no one will come to borrow it from me. Everybody else will just drive its value down. That means everybody loses. Well, everybody, that is, except…….oh shit!! Everybody loses except for the Americans! They get to consume more than they can afford!

They have this great privilege because theirs is the default currency, so that makes the US dollar their currency, and everybody else’s problem. They get to continue having a trade deficit because everybody needs the US dollar. Everybody thinks they need the US dollar, even though everybody already has too much of it (well, everybody except me!)

2006 – Every one is just going mad! Everybody keeps selling to the Americans for US dollars, and the American just keep printing more of it! They print it to fund their citizen’s borrowings! They print it to fund their government’s borrowings! So they keep on consuming, and buying stuff from everybody. Every American is now indebted up to their eyeballs and yet everybody still keeps selling to them. These foreigners need to stop doing it! Don’t they realize what it’s doing to the value of my own dollar holdings? I also need to stop selling to the Americans, but nobody else is coming up to the plate to replace them as a net deficit trader. I am ready to start accepting someone else’s currency, like the Euro, or the yen. But these Japs! And these Krauts! They also think they have to be net surplus exporters. They shouldn’t do that! Everybody cannot be a net exporter. For every net exporter, there should be a net importer. And that net importer can never be me, so they should step up to the plate and import! Why do they not do it?

2008 - I am now very worried about the value of my dollar holdings. I am still the biggest exporter, and I continue to get US dollars. I no longer need more of them, as I have more than I could ever need. And yet, I don’t want to start spending it. I have to keep exporting, not start buying. What to do? I can foresee the price of all commodities going up in the future. My people are starting to demand more luxuries. And the value of all commodities, still foolishly denominated in US dollars, can now be expected to go up in the future, as the value of the US dollar will likely go down, if the tsunami of dollar printing continues. I have to do something. I will start buying commodities. Everything I can put my hands on. I need to spend some money, but I don’t want to spend it on other people’s work. I will spend it on stuff that will become dearer when the US dollar loses value. I will now buy up all the precious metals I can find – copper, nickel, gold. I’ll buy cotton, I’ll buy oil, all the commodities that will go up with dollar depreciation.

2010 – I now have more US dollars than I’ll ever need, and now I have more precious metals than I’ll ever need! What am I going to do with all this stuff? Americans are no longer spending like they used to. Many of them have lost their jobs (Ha! If they haven’t been so foolish, I would not have managed to snag some of these, and they wouldn’t have managed to bring their economy down to its knees with their silly financial maneouvers!) Now with Americans no longer consuming as much, who is going to buy my precious commodities? They have all gone up in my price because the dollar has been losing value, and also because I have been buying up everything in sight. But now who is the greater fool who will buy this stuff from me?

2012 – Why does no one step up to the plate? These Germans, these Japs, the French and the British – they should all be net consumers by now. Otherwise, why do they still keeping calling themselves the developed economies? They should be buying from me, so I can avoid having to sell more to the Americans, and they should start buying more from the Americans. Americans have not been buying as much, and neither am I inclined to get more of their mickey mouse money. So why does no one care? I have had a talk with all these other nations, and we now trade with each other in our respective currencies. But unless they start buying more from the Americans, the Americans will continue to incur deficits, and continue to destroy the value of my dollar holdings. They have to come and save me!

2014 – Nobody accepts US dollars anymore. All my trading partners accept each other’s currency, but not the American’s currency. My dollar holdings’ value continues to plummet! Do I dare start incurring a trade deficit with the Americans? Unthinkable! And yet Americans continue with their trade deficit. It seems they no longer are interested in making stuff anymore. All they are good at making is more US dollars!

2016 – I use some of my dollars buy up American real estate. That only ends up increasing the value of their real estate, making the Americans feel richer. Now they’re starting to spend again! What? More trade deficits for them? What about my dollar holdings?

2018 – There’s another real estate bust in the US! Now I have a lot of worthless dollars, a lot of worthless metals, and I have a lot of worthless American real estate! These Americans continue to confound me!!!

2020 – The Americans have finally spent themselves into a black hole, and have decided to abandon the dollar. Now they’re issuing an entirely new currency, and all my dollars, accumulated after all those years of hard work and self restraint, they’re all worthless! Damn these people! I curse the day I ever decided to accumulate someone else’s currency. I was no better than if I had accepted seashells for my wares. Woe is me.

How many rich fools are there?

Two weeks ago we were inundated with reports that Goldman Sachs was launching a private fund, open exclusively for its rich retail cients, that would invest in the still private shares of Facebook. Facebook, as we all know, is the current darling in the tech industry, and is widely expected to be a sure seller in a potential IPO.

Nonetheless, there was something peculiar about the financing route taken by Facebook, as arranged by Goldman Sachs. It was going to do a private placement transaction, and rather than do a public listing via the IPO, it was going to place share via this fund set up exclusively for Goldman clients. Now a lot of people have speculated about the reasons for this: that founder Mark Zuckerberg doesn’t really want Facebook to be a public company, what with all the public disclosures and the public scrutiny that comes with being public. It was speculated that he wanted to get the benefits of a widely held share base, via the Goldman fund, without the costs of being public. Should he or any of his staff ever want to unload his shares, he does not have to go through the public market, and would just sell it to this fund composed of his rich admirers.

Now the question I have yet to see asked, or answered, is just what kind of investor is interested in this kind of investment? What motivates them to put a minimum $2 Million dollars of their money to take part in what probably has to be the most non-transparent financing in history?

Let’s ask the following questions, for example: Did the investors in the fund see an actual prospectus detailing Facebook’s operations and detailed financial statements? Did they get to see adequate disclosures about Facebook’s major suppliers, directors, employees, partners, ventures, and activities, so as to give them adequate confidence that they are getting what they are paying for? (The transaction puts Facebook’ value at about $50 Billion).

Now given that they are buying into a fund, and not individually as shareholders, they are likely buying without the requisite voting rights. And though the fund itself may have some voting rights, will the voting control be large enough to matter in Facebook decisions? Sure, investors give up their proxy votes to fund managers all the time when they put money into funds, but they are putting their money into a fund that owns nothing else but Facebook shares. Are these investors confident that the fund manager (that would be Goldman) has their best interests at heart, or should they be worried that their interests are subordinate to the lone client at the other end of the transaction (that would be Facebook)?

How about selling their shares? Since they are essentially buying into a fund that is closed to people who are not Goldman clients who already have $2 Million in change lying around, are they essentially buying into an illiquid investment? And how long do they expect to hold onto the investment? Should they ever need the money ASAP, will they get it without large haircuts on their investment?

These questions lead me to believe that there can possibly be two strongest motivations or reasons any investor have in joining this elite group of Facebook ‘friends’. They are either, as I said, the biggest Zuckerberg fans, who believe in his long-term vision of growing the company…. or they are pure speculators who know a Facebook IPO is on the horizon. They are buying blind into an entity with negligible voting rights, at a stage when Facebook is expected to provide negligible disclosures (otherwise Facebook would have done the IPO now, outright), and at terms that clearly give Facebook the upper hand (they are investing into a fund investing exclusively in Facebook shares).

My guess is that more of the eventual investors came from the latter, and many probably had their eyes on an IPO exit from the get-go. In short, they are rich dudes praying for the IPO to happen, and hoping for greater fools to come begging for shares down the line (unless Facebook does eventually show reasons for them to stay, in pubic disclosures later on).

Is job outsourcing already a piled trade?

Is job outsourcing already a non-sustainable piled trade?

Job outsourcing has been a great source of increased competitiveness and cost effectiveness for a lot of companies. Jobs seen as prime candidates for outsourcing were those that could be done with minimal face to face contact with customers and other colleagues, and resulted in perceived minimal intrusion to regular company workflows and processes if they were moved offsite. Outsourcing staff jobs to offshore locations that promise decreased labour costs has led to increased profits, very important especially in the aftermath of the recent economic downturn.

But as early outsourcers saw increased cost competitiveness, other companies have also joined in to keep from falling behind in terms of competitiveness. This could be the commercial version of what is known in hedge fund circles as a piled trade, a trade that is profitable only if one fund does it, but when everybody else does it, the trade loses its profitability, and eventually becomes a dangerous one, as getting out of it becomes impossible without breaking down the house of cards that is now the trade. If everyone is already in the trade, then everybody is a seller, and there are no longer any buyers.

The recent downturn might have been a good opportunity for companies to offshore more jobs, as the recent economic downturn led to decreased sustainability of existing labour cost structures. This economic phenomenon, good for the health of particular companies, falls into a fallacy of composition when looked at in terms of the general economy. When a company outsources jobs, previous employees will have to find similar work in other companies. In the absence of work in competitors, they will have to look in other industries. What happens when entire industries outsource jobs as an intricate part of overall cost strategy?

People who are unable to find jobs stop becoming consumers, and as such, this has knock on effects in many industries who need their continued consumption to generate continuing sales. As more consumers drop off the consumer ranks, this puts the viability of more businesses in jeopardy, as this results in a general fall in aggregate demand.

The remaining consumers left with jobs will have to take on the slack in demand left by colleagues no longer wiling or able to buy. The next logical step would be for companies to start tapping the newly emerging foreign economies now realizing an upturn in jobs generation and consequently surging demand. Failing to do so, many companies will find themselves the losers in a game of musical chairs where the last one unable to find substitute consumers falls off the ranks of solvent companies. This could then lead to the next round of demand destruction and the next loser in the musical chairs game.
To simplify this scenario, in an economy where everybody is an outsourcer, then everybody is by necessity a seller, and there are no longer any buyers left to buy the goods.

Will the emerging economies’ surging demand be enough to compensate for the decreased demand from locals who have lost jobs? Will companies who have hollowed out their staff ranks find their markets in the new markets they are creating via offshoring?

My guess is not everyone will find viable demand abroad. And especially if the new jobs created do not pay as well as the old ones they have made redundant (that is why they outsourced, to find cheaper labour), many higher cost goods and services will likely fall off the market as unaffordable luxuries, even in emerging economies. If people who make iPads cannot afford to buy iPads, then there will be no market for iPads. If people who make Fords can no longer afford to buy Fords, then there is no market for Fords.

So, is job outsourcing already a non-sustainable piled trade?

Questions for 2011

It's a new year, and many are making forecasts. I don't have any, but I have some questions on how likely some scenarios others have predicted in leading to a more general problem.

Have emerging economies, particularly the BRICs, sufficiently decoupled from the US economy to withstand a possible double dip recession? How likely is a popping of the Chinese real estate 'bubble'? Will a popping lead to a Chinese bank crisis?

Have other emerging markets decoupled from China, at least in the eyes of portfolio managers? Will a bank theoretical crisis in China lead to a sudden cascade of hot money out of other emerging markets?

Are Europeans confident about the strength of the Euro? If confidence withers, will this lead to large outflows of savings? To which currency? (I think I know where, should this ever happen)

Is the US recovery in danger from a sudden commodity spike? What effect will a possible double dip have on the rest of the world? Will these economic linkages be a danger, or is each area of the world stable enough to withstand heightened risk elsewhere?

Is raising inflation expectations a good idea, and will it work?

There have been several discussions about the viability of monetary policy right now, just when the economic authorities need to create demand while at the same time rates are at the zero bound*

Focusing on interest rates had always been what monetary authorities focused on. And for a long time, it seemed the effective and fiscally prudent policy choice. For as long as tweaking rates could increase or decrease economic activity, there was no sense in putting focus on extensive fiscal action. Fiscal policy determination is a politically-charged process, and very often ends up being directed at wasteful projects, and cutting the most fruitful activities in the worst possible way.

But for as long as the challenge is to simply reduce demand, increasing rates will do. If the challenge were to increase demand, as it is in the US right now, you also have to address several factors. I could list a few things other than rate/price that could influence, or put a limit on demand at the individual level.

Level of current income, level of current expenses, current level of indebtedness, capacity to service existing debt, capacity to borrow more-to financing more spending, confidence in stability of future income, expectations about future increases in fixed expenses, confidence in future value of purchasing power of current savings (if you have any), non-existence of any lender calling on their debt, confidence in future positive value of existing savings/investments/net worth, ease of liquidating current savings –to finance current spending, tax implications of using current income/net worth to spend now vs. later, confidence about over-all economy, and how it is being run… the list goes on further.

These can be addressed either directly, via fiscal policy action, or indirectly, via monetary policy action. When you are at the zero rate bound, the monetary policy tools to use (QE, etc) have the objective of increasing inflation expectations. If people expect heightened inflation, monetary authorities intend them to do several rational acts: buy stuff now that they would have postponed ‘til the future, and make investments in businesses, stocks, and others that rise in tandem with inflation.

Examples were made of buying a canoe now, buying a farm, buying oil and gas shares, as well as buying a restaurant meal now. The point was also made that rising inflation will spur people to borrow money, since the rising inflation will increase the value of physical assets, while inflating away the real cost of borrowing.

But rising inflation expectations cuts both ways. If a lender is going to lend to a borrower to buy his canoes now, it's now going to lend him at the rate that incorporates the higher inflation expectations for next year. So the higher borrowing rate effectively offsets the value of buying canoes now rather than buying it at a higher price next year and just borrowing less (or not at all). There's no way to get ahead if the other side also knows what one side knows.

And if Farm sellers and oil and gas shares owners know that inflation will be higher next year, they won't sell their farm now. Or they will sell their shares at a price that reflects the higher inflation. Intentional buyers may end up not wanting to buy anymore.

Having the restaurant meal now will likely be the best bet to get ahead, since the restaurant will likely still be selling at the price level that he already bought his cost inputs. But then, if one is worried about looming inflation, he may be less likely to eat out, too. For if people can be influenced that inflation can and will be increased by monetary authorities, they can also, and might be, influenced that inflation will get out of control (maybe because the currency is depreciating and higher imported input costs are wreaking havoc on the economy). In this sense, increasing inflation expectations may backfire, and cause demand destruction, the opposite of the intended effect. He may now be thinking that he needs to preserve his soon to be diminished purchasing power for basic necessities. He will trade down to less costly substitutes. He will ration his supplies. He will repair stuff rather than buy new ones. These are rational actions to make during runaway inflation.

It would be better yet, if the challenge were to increase demand, to just directly address the following: level of current income, level of current expenses, current level of indebtedness, capacity to service existing debt, capacity to borrow more-to financing more spending, confidence in stability of future income, expectations about future increases in fixed expenses, confidence in future value of purchasing power of current savings (if have any), non-existence of any lender calling on their debt, confidence in future positive value of existing savings/investments/net worth, ease of liquidating current savings –to finance current spending, tax implications of using current income/net worth to spend now vs. later, confidence about over-all economy, and how it is being run…..via fiscal policy action instead.

*This post flows from two unrelated comments I made in discussions elsewhere. It doesn't particularly react to the original post where those discussions arose.

Flaws in the belief in effectiveness of Fed monetary easing

QE2 is hailed by some economists as the tool needed to jumpstart the laggard US economy. The mechanism here is - The build-up of the monetary base eventually leads to rising inflation expectations. This is supposed to then encourage people to start buying things now, in anticipation of rising future prices, which then leads to a positive multiplier effect for the economy. There are several flaws in this belief. Here are reasons that I could think off the top of my head:

Debt among economic agents is ignored/inflation expectations is over-estimated. Debt does make a difference. Inflationary measures can be hindered in a recession economy with a lot of debt, because the indebted that are undergoing deflation, i.e. balance sheet recession, will not be induced to make more purchases if paying off the debt is already eating up much of their income. They will hope that the non-indebted ones will come to the rescue, and be induced to consume more via increased inflation expectations. But then, the non-indebted have to be convinced that the ongoing balance sheet recession among the indebted will not counteract any of the inflationary measures.

This was effective on the way up to becoming a debt society. Now no longer.

Transmission to the larger economy will be via even more debt. QE2 puts more reserves on the banks, but no money goes directly to people who will spend it on consumption. For this to get to the end-consumers, those remaining non-indebted will have to take one for the team, get into debt, and spend it in the local economy.

On the way towards becoming a debt-centered society, people managed to continue their consumption activities by getting into more debt. They were able to secure debt because they were able to borrow against the increasing values of homes and investments. This increasing value was only possible for as long as more people were chasing into appreciating assets, but had to stop when many people can no longer realistically afford the increasing prices. The debt deleveraging that follows results in depreciating assets, and which leads to more insolvencies, leading to even more deleveraging.

Getting into new debt will be the last thing on the minds of those currently deleveraging.

It floods the banking system with trillions in reserves but zero new capital. Banks do not need reserves to do their lending activities. If a bank is to grant more loans, it needs adequate capital, in order to buy risk-weight assets, and needs to have credit-worthy borrowers. If it has both of these, it can always raise any deficiency in its reserves, i.e. deposit base, by borrowing in the interbank market, or from the Fed’s discount window. If it doesn’t have adequate capital, or a compelling borrower, no loans will be extended.

The continuing deleveraging doesn’t help in building up bank equity, or confidence to lend.

It assumes that in deciding to borrow, companies care more about cost of funds than improving sales and profit. QE2 is supposed to decrease long-term interest rates. That’s meant to elicit more company borrowing for long-term capex. But without improvement in aggregate demand, sales prospects and profits do not improve. Also, to the extent that QE2 results in more funds being diverted towards asset bubbles, it’s going to make cost of funds more expensive.

These arguments doesn’t necessarily mean that I believe monetary policy/quantitative easing will have no effect on sentiment whatsoever. I think the effect will not be evident while having a long build-up. In the end, there will be a big snap. This comes when people lose confidence in the debased currency (which is toxic when not matched by a growing economy), and people begin to trash it.

Computing for the Bail-Staff jobs save factor

My last post expressed surprise that McD’s was involved in the massive Fed emergency program. But then, I got to thinking, if one of the purposes of the bailout had been to save jobs, then McD’s should be right up there with the rest of them, right? After all, McD’s employs lots of entry level staff positions, contributing significantly to aggregate demand. So I wondered further, why don’t we try to evaluate the effectiveness of the Fed bailouts in terms of saving jobs? What if we were to use a new metric, something like the Bailout dollar amount to number of staff jobs saved, or more simply, a Bailout to Staff multiple. To be short, let’s simply call it the “BS factor”. Here then is a table, evaluating the Fed emergency loans in terms of its BS factor among a sampling of recipients (click for full view):
From the list, it is evident that McD’s actually registers the lowest multiple on our newly-minted “BS factor” scale. The highest BS factor belongs, far and away, to Bear, followed distantly by a close tie between Merrill and Morgan.

Citi and BofA register much lower BS factors because of their higher staffing numbers (Taking into consideration, of course, that much of this staffing number is actually outside the U.S. putting them outside the Fed’s purview. But then, every nation that hosts a Citi or a BofA branch likely has sizeable dollar holdings. While the dollar is the US currency, if the Fed debases, it is everybody else’s problem).

Now I don’t know if looking at emergency loans provides a comprehensive picture of the overall assistance back in ’08. After all, the Fed also took on derivative positions and bought toxic assets, so this table may actually be discounting a large multiple of BS factor .

Also, looking at the “beneficial” effects of the bailout simply on the number of staff positions saved is an incomplete analysis. After all, many of the bailoutees were highly interconnected entities whose failure may have caused even more staff positions lost in the economy, whether directly employed by the bailoutees, or not. (A failure by one of these guys has a negative effect on the viability of companies like McD’s, whose business operations are facilitated by the financial system). So the table may also be overestimating “BS factor”.

If there's anything to learn in this exercise, it’s nigh impossible to calculate the effectiveness multiple when we are talking about bailouts – you get lost in all the layers of BS.