Enter the Swan

Charles Hugh Smith (along with many, many, many others) thinks there may be a great decoupling as the world sinks deeper into the mire, and that the dollar could be set to benefit:

This “safe haven” status can be discerned in the strengthening U.S. dollar. Despite a central bank (The Federal Reserve) with an avowed goal of weakening the nation’s currency (the U.S. dollar), the USD has been in an long-term uptrend for a year–a trend I have noted many times here, starting in April 2011.

That means a bet in the U.S. bond or stock market is a double bet, as these markets are denominated in U.S. dollars. Even if they go nowhere, the capital invested in them will gain purchasing power as the dollar strengthens.

All this suggests a “decoupling” of the U.S. bond and stock markets from the rest of the globe’s markets. Put yourself in the shoes of someone responsible for safekeeping $100 billion and keeping much of it liquid in treacherous times, and ask yourself: where can you park this money where it won’t blow up the market just from its size? What are the safest, most liquid markets out there?

The answer will very likely point the future direction of global markets.

Smith is going along with one of the most conventional pieces of conventional wisdom: that in risky and troubled times investors will seek out the dollar as a haven. That’s what happened in 2008. That’s what is happening now as rates on treasuries sink to all-time-lows. And that’s what has happened throughout the era of petrodollar hegemony.

But the problem with conventions is that they are there to be broken, the problem with conventional wisdom is that it is there to be killed, roasted and served on a silver platter.

The era of petrodollar hegemony is slowly dying, and the assumptions and conventions of that era are dying with it. For now, the shadow of that old world is still flailing on like Wile E. Coyote, hovering in midair.

As I wrote last week:

How did the dollar die? First it died slowly — then all at once.

The shift away from the dollar has quickly manifested itself in bilateral and multilateral agreements between nations to ditch the dollar for bilateral and multilateral trade, beginning with the chief antagonists China and Russia, and continuing through Iran, India, Japan, Brazil, and Saudi Arabia.

So the ground seems to have fallen out from beneath the petrodollar world order.

Enter the Swan:

We know the U.S. is a big and liquid (though not really very transparent) market. We know that the rest of the world — led by Europe’s myriad issues, and China’s bursting housing bubble — is teetering on the edge of a precipice, and without a miracle will fall (perhaps sooner, rather than later).

But we also know that America is inextricably interconnected to this mess. If Europe (or China or both) disintegrates, triggering (another) global default cascade, America will be stung by its European banking exposures, its exposures to global energy markets and global trade flows. Simply, there cannot be financial decoupling, not in this hyper-connected, hyper-leveraged world.

And would funds surge into US Treasuries even in such an instance? Maybe initially — fund managers have been conditioned by years of convention to do so. But how long  can fund managers accept negative real rates of return? Or — much more importantly — how long will the Fed accept such a surge? The answer is not very long at all. Bernanke’s economic strategy has been focussed  on turning treasuries into a losing investment, on the face of it to “encourage risk-taking” (or — much more significantly — keep the Treasury’s borrowing costs cheap).

All of this suggests a global crash or proto-crash will be followed by a huge global money printing operation, probably spearheaded by the Fed. Don’t let the Europeans fool anyone, either — Germany will not let the Euro crumble for fear of money printing. When push comes to shove they will print and fiscally consolidate to save their pet project (though perhaps demanding gold as collateral, and perhaps kicking out some delinquents). China will spew trillions of stimulus money into more and deeper malinvestment (why have ten ghost cities when you can have fifty? Good news for aggregate demand!).

So Paul Krugman will likely get something much closer to what he claims to want. Problem solved?

Nope. You can’t solve deep-rooted structural problems — malinvestment, social change, deindustrialisation, global trade imbalances, systemic fragility, financialisation, imperial decline, cultural stupefaction (etc, etc, etc) — by throwing money at problems. All throwing more money can do is buy a little more time (and undermine the currency). The problem with that is that a superficial recovery fools policy-makers, investors and citizens into believing that problems are fixed when they are not. Eventually — perhaps slowly, or perhaps quickly — unless the non-monetary problems are truly dealt with (very unlikely), they will boil over again.

As the devaluation heats up things will likely become a huge global game of beggar thy neighbour. A global devaluation will likely increase the growing tensions between the creditor and debtor nations to breaking point. Our current system of huge trade imbalances guarantees that someone (the West) is getting a free lunch , and that someone else (the Rest) is getting screwed. Such a system is fundamentally fragile, and fundamentally unstable. Currency wars will likely give way to economic wars, which may well give way to subterfuge and proxy wars as creditors seek their pound of flesh, and debtors seek to cast off their chains. Good news, then, for weapons contractors and the security state.

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34 thoughts on “Enter the Swan

  1. USA govt’s/taxpayer’s backstopping of derivatives markets/exchanges is the proof that the decision has been made (inevitable, obviously) that a hyperinflationary outcome has been settled upon. This was always unavoidable. Here comes Benny Boy’s USD front-lawn dump. Investment Disclosure: 100% PHYSICAL Gold (NO paper gold) for the last 4 years. The gains over that time are miniscule compared to what lies ahead. Watch! It’s close, real close. http://preciousmetalspete.blogspot.co.uk/

    • USA govt’s/taxpayer’s backstopping of derivatives markets/exchanges is the proof that the decision has been made (inevitable, obviously) that a hyperinflationary outcome has been settled upon. This was always unavoidable.

      Interesting view. Not sure I agree. The establishment’s great problem, I think, is that they never agree. But as a general rule, I’d say the establishment is where it’s been for the last half-century — in favour of mild-to-moderate inflation that screws creditors just a little, but not too much. Creditors get a slightly devalued pound of flesh.

  2. What do you think of the gold-backed EMU redemption fund? Wouldn’t that be an interesting way of re-introducing gold on the monetary scene? Somewhat similar in some regards with other ideas presented by ZH: http://www.zerohedge.com/news/jim-grant-gold-backed-bonds-and-hope-leeches , http://www.zerohedge.com/news/guest-post-gold-bonds-averting-financial-armageddon

    PS: On this topic I’m more on CHS’s side (presented my arguments in the previous comment thread); I think I’m beginning more and more to dislike this idea of a systemic reset. If the world doesn’t seem to stop right now, then it means there’s a more general kind of equilibrium that has been reached – and maybe there are more peaceful ways of solving the other imbalances. ZH does present constructive opinions, but they’re always from others – Tyler doesn’t seem to side with anything except the systemic reset.

    Maybe initially — fund managers have been conditioned by years of convention to do so. But how long can fund managers accept negative real rates of return?

    How long – as in an alternative to what? Hanging themselves, or banging their heads against a wall fearful of the systemic reset? I’d say they’d wait even 100 years if that’s the best alternative, and that’s what it takes.

    • What do you think of the gold-backed EMU redemption fund? Wouldn’t that be an interesting way of re-introducing gold on the monetary scene?

      I think it’s necessary collateral, to be honest. If the money is going to keep flowing, it is prudent to have some barriers to defeasance.

      I think I’m beginning more and more to dislike this idea of a systemic reset. If the world doesn’t seem to stop right now, then it means there’s a more general kind of equilibrium that has been reached – and maybe there are more peaceful ways of solving the other imbalances. ZH does present constructive opinions, but they’re always from others – Tyler doesn’t seem to side with anything except the systemic reset.

      I can’t speak for Tyler, but I just kind of feel like systemic reset is an inevitability, either by hyperinflation or by default cascade. There’s just too much debt and debt-format securities/derivatives, etc as “wealth”. The more they build, the more fragile the construct becomes.

      By all means, let the system play at extending and pretending, but it won’t work.

      How long – as in an alternative to what? Hanging themselves, or banging their heads against a wall fearful of the systemic reset? I’d say they’d wait even 100 years if that’s the best alternative, and that’s what it takes.

      At negative real rates, you will run out of money, or out of investors. Eventually, funds will go to safer assets, that are not yielding negative rates. Gold, in other words. Gold, that is robust to systemic collapse.

      • But isn’t the idea of gold backing that of saying: OK, here’s how your real wealth looks like, and what you see is all that you can get (hence probably setting a new gold price), and if you want more wealth, you’ll have to create more of this (gold). About the negative real rates: depends how big they are (negative rates) and for how long, otherwise, for what you said is too much imaginary wealth, it may be acceptable for a long time (US did it after WWII – financial repression I mean – and so did others).

      • I would add, there are many types of possible gold-backing; but one could be done so as to not only cover (through the new price) the bare essentials so as to not default, but the price could be set even higher in such a hypothetical backing, so as to leave breathing room for fiscal adjustments. Or maybe the price doesn’t have to be set explicitly, but the price could rise in a FOFOA-style readjustment of values so as to cover more and more of the backed bonds. In a happy-ending outcome for the EUR, the backed bonds would attract investor confidence spurred by a potential new debt-ceiling debate in the US (which would shift investors back from treasuries to EMU debt) – and a consequent rise in the price of gold.

        • I don’t think any revaluation of gold beyond supply/demand is necessary for FOFOA’s view to come at least partially true. I think the long-term reality of deeply negative real rates is effectively game over for anyone who doubts FOFOA that gold will become the only viable, reliable long-term store of value.

        • Maybe, maybe not. I know it’s dangerous to have convictions in the financial markets. The markets can stay irrational or corrupt for longer than we can stay solvent… or maybe even alive.

  3. Good article.
    With the China property bubble deflating, and the Eurozone going bonkers, the dollar is at least the tallest midget in the room. But it could flip very quickly.
    Politically the States seem totally polarised. The debt level debate that led to their being downgraded will need to be repeated pretty soon. And imagine the effect of Obama losing the popular vote but winning the electoral college.

    • Thanks, by the way I rate Obama’s chances of winning at about 35%. Trade war with China here we come.

      I am also kind of amazed that Obama didn’t try and play FDR’s game of fireside chats right from the very start. He seemed like an effective communicator on the campaign trail, but once he got into the White House he became extremely distant from the nation at large. He should have realised from his experience as a candidate that it is essential in politics to give the public a narrative they can buy, and that evaporated so quickly after he was elected.

  4. I suppose we can expect them to print, and print, and print, since it is the option that allows them to keep the ship afloat for just one more day….until one day it doesn’t.

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  10. With everybody’s wealth tied up in the US Dollar, I think, politically, the US can do whatever it wants.

    • The opposite, Buddy. With the US needing everyone’s wealth tied up in the dollar to finance its deficits, they can make more and more demands of the U.S.

      • I would suggest otherwise. That is why the Treasuries are negative yielding and the US dollar stonger. Everybody with wealth and influence is dumping domestic currencies etc.

        They will buy their way into the USA to escape WW3. LIke they did in WW2

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  12. Someone twittered a link to “Enter the swan” (ZH version) to Jim Rickards, and got this response:

    Jim Rickards @JamesGRickards
    @edbmd @zerohedge & Aziz miss fact that bond investors get huge dvo1 duration cap gain as 10-yr note goes from 1.6% to 0.5%. Crash is later

    I have no idea what that means, other than that Rickards apparently disagrees… :)

    • He appears to disagree on the time scale.

      In simplespeak:

      A lot of people still taking yields bought at much lower prices, so will be happier to hold on as rates go lower.

      http://en.wikipedia.org/wiki/Bond_duration#Dollar_duration.2C_DV01

      Now beyond the fact that if you bought at 1.6% you are still getting burned by negative real rates, this is actually a fair point, but with rates scheduled to stay low until 2014 and beyond, the whole yield curve (even with respect for duration) is going to get squeezed more. Less and less bondholders will have bought when rates were higher, more and more will eventually realise that gold is a safer haven.

      • Heh, JGR just noted my point:

        Idea is buy, sell, get out. Be nimble. Not recommended, but that’s what happens

        Sounds like a bubble to me!

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