Tuesday, October 21, 2008

If the USD didn't have reserve currency status...

(here comes a stream of consciousness) We'd be fucked. Argentina announced the nationalization of private pension funds today in order for the government to fund its external debt obligations coming due. It must be pretty hard being a pensioner/retiree there today--having your hard earned life savings be put towards buying government debt on a currency that is at best going to be severely debased by the time the crisis blows over and at worst a complete zero by the time Kirchner government is done with it. All because you can't roll over and refinance the debt you've once borrowed from other countries... life sure is tough for an emerging market

Now why isn't the U.S. government suffering the same fate? People are willing to keep buying our bonds to the point where 2% nominal and negative real yields is totally acceptable. The fashionable interpretation of this is that the dollar is actually considered a "safe haven" investment, that this is only because people believe foreigners flock to our currency because its solid, backed by a 14trn dollar economy and the most liquid capital markets in the world. I would love to see if this is the case... if there were some way to pool together the data on the actual demand for dollars out there--and whether we could break it down into real demand vs. short covering (foreigners having buy back the USD to repay eurodollar debt that they can't find refinancing for, or americans themselves bringing money home as international asset prices collapse and the dollar strengthens)... because why anyone would want to accept such absurd yields--on a currency that will most definitely have to be debased should the financing spigot from the likes of China and Japan ceasees--is beyond me. The party is coming dangerously to an end... and at some point, the trillion dollar nationalization programs and investment programs on assets that are likely to be worth much less then they are at "a little less than held to maturity" (in the words of Bernanke...), along with a NEW stimulus package in the works will seem dauntingly impossible as a sensible form of collateral to our creditors. The pyramid scheme goes way beyond wall street--the united states of america is, in a way, the biggest subprime issuer there is. And it's only allowed to function to the extent that "lending standards" of creditor nations are lax, and its in their interest to keep us borrowing because their concern may not ever be the realization on the repayment of our principal, but on the perpetual fees and interest garnered in the form of unsustainable account surpluses on their books (the only difference being that they haven't somehow securitized these and moved them off balance sheet into obscure investment vehicles to be sold to dumb money... maybe even back to americans!). But its scary to see moods changing in Beijing, Tokyo the Eurozone, with voices calling out for a massive revision of the Bretton Woods system--and a call for the diversification from U.S. treasuries (which, if they are serious about they should do it soon while yields are still at 2%). If we are moving to a basket of currencies, or maybe back to the gold standard, it will NOT be fun for America. Real interest rates are going to balloon, and our currency is going to have to be severely debased in order to repay our obligations--that will be the doomsday scenario, and contrary to popular belief in a deflationary environment going forward, we actually have hyperinflation and a great big kick in the balls to teach us a lesson that's going down in history books--never spend beyond your means, educate yourself and work hard, save and invest. However disappointing, this is most likely the inevitable scenario anyway as the current international financial system as we know it is broken. How Nixon managed to make everyone drop out of the Gold standard because we can't repay our debt is beyond me (maybe something that involved having lots of nuclear bombs and the world's most sophisticated military at the time). It was diabolically genius, but something I doubt we can pull off again (what are we going to use as the next fake reserve currency that we can print as much as we want?). But today we still have King Dollar, and the music keeps on playing... and people can arguably love it as the best store of value there is around the world, for which as a country we can get unlimited financing for even in the worst of times. Sadly, it doesn't change the fact that foreigners are slowly coming around to the realization that unbridled anglo-saxon finance and the bretton woods system is broken, that its done much to encourage an unsustainable disequilibrium in the macroeconomic picture of the world (with the U.S. severely bloated on useless consumption and the Asians fooled by the possibility of sustainable economic growth from purchases by a customer that could potentially never be able to pay for any of his buying) owes its origins to a fiat money serving as reserve currency--a store of value that's supposed to be relatively permanent. I've pretty much accepted that the U.S. won't be a comeback kid as it was after the 70s, and that there won't be a cent of left in social security institutions by the time i retire. Unless we have a new economic paradigm or a technological/business landscape change that could match the industrial revolution in output growth and launch us back into profitability as a nation, everything essential to a well functioning financial/social system is bankrupt... pensions, medicare, social security. We won't go as far as to take people's retirement accounts and 401k's to fund our nation's obligations quite yet... but what are we going to do, really, when China and Japan says screw you?

Okay, that's my bearish rant--excess liquidity (i.e. stupid money) will take a while to come back--this massive systematic deleveraging we have today will go on for quite some time. Pick your poison: 1.) slow death by japan-esque decade long deflation and economic recession, or 2.) massive inflation and output loss to end it quickly, so we can get back on our feet and quit dragging it on?

I like to think of myself as an optimist. When this is all over, we will be fine. We do indeed have the world's largest economy of 14 trillion (peak cycle output though?), relatively the most efficient/fair legal system, and the world's most liquid capital markets on the backs of those two giants. So hopefully our politicians still play it cool, come up with the right kind of regulations targeting excess levered risk taking (not blanket regulations hampering financial innovation), spend as little money as possible doing it, and get over the hope that we'll actually make money out of this crisis (cuz we won't, not by buying mortgaged assets at close to held to maturity value, which is most likely the value that our banks are still carrying them for on their balance sheets, and can't sell for less unless we suffer more write-downs leading to more equity injections). I sure hope the government doesn't botch it up yo!

Say hi to your mother for me aite?

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