The Financial Apocalyptics Are Back
Gloom and doomers have often been wrong, but not always. Crises do happen, writes Rober Blumen. In recent years, a number of countries have had their currency collapse or have defaulted on foreign debt. Recall the Asian contagion, the Mexican peso crisis, the Russian ruble crisis in 1998, and the Argentine banking crisis. America is not inherently immune from such a crisis. Perhaps we have one unfolding now in the sub-prime sector, though there is still debate about whether it will remain contained there or will spread. Either way, the laws of economics apply to America as well anyplace else. FULL ARTICLE
Comments (20)
Mark
Rambling article, that never addressed it's main point in any definitive way.
Is the trade deficit or capital surplus being used to support enough increases in future production to offset current consumption?
Published: July 25, 2007 9:25 AM
Gabriel
Mark, according to the Federal Reserve's June 7th data on the flow of funds in the US, the answer is yes: Investments in capital were greater than capital consumption in 2006. The data is below:
Gross domestic investment: $2,643 billion
Consumption of fixed capital: $1,577 billion
Imports minus exports: $763 billion
Published: July 25, 2007 12:28 PM
Alex
'A balance of payments deficit ... is nothing to worry about because it cannot exist. Whether one ought to worry about having a trade deficit and an equal capital surplus ... depends upon how the capital surplus comes about. If it consisted of foreign capital being investment in British industry, the appropriate reaction would be to ring the bells of St Paul's for an hour and a half daily and get the Archbishop of Canterbury to lead us in prayer for twice as big a trading deficit. If the capital surplus consisted of foreign money being lent to our government, however, we would want to know what the government was spending it on ... if they were using it for consumption expenditure, we ought to form up and tell them to desist instantly from such notoriously spendthrift and disastrous behaviour.'
J. Enoch Powell, 1976
Published: July 26, 2007 2:49 AM
Spectator
A crisis seems inevitable, the hard part is to know when and in what form. Glad to have people like Schiff remind people of that.
While free markets are the best system we can possibly have, we need to be acutely aware of the punishing distortions possible at any time or place.
Whether caused by a misguided Fed, or a powerful and irrational market player, distortions have a way of testing one's faith in free markets. Unfortunately, people are then easily led to support cures, that include more government intervention, that are worse than the disease. Depressing, really.
Published: July 26, 2007 5:40 AM
Travis
I read the book and while there seem to be holes in some of his ideas, some of the charts are skewed from a time frame and numerical perspective, he makes a good case. For the first time in my investing life, I am completely out of US securitues and mututal funds and am in commodities (mostly precious metals and uranuim producing companies) as well as oil. Who knows what is coming, but with the Fed obfuscation of statistics and termination of Fed M3 reporting, I would bet against most Government assurances about the health of the economy and the US dollar (especially since they talk about working for a strong dollar and act exactly the opposite). I believe in the truth of competing currency devaluations going on right now which can only prove diastrous in the long run for those holding cash and paper.
Published: July 26, 2007 5:37 PM
RogerM
Can't wait to read the book. The more Austrian econ I read, the more convinced I become that it has great insights for investing. I just finished Hayek's "Prices, Production and Profits" and realized that Austrians could effectively time the stock market by purchasing stocks in capital intensive industries, shifting to consumer goods industries and commodities as the expansion matures, and going to cash/gold near the end of the boom. You can identify the end of the boom because profits are higher than normal, which happens because demand for consumers goods is high but production insufficient to meet demand, so prices rise while wages don't.
Alex, the quote from J. Enoch Powell is great and right on the mark! Thanks!
Robert Blumen's comments on the trade deficit are welcome as well. While it's true that we are selling assets in order to pay for imports, that's not a bad thing as long as we are creating assets as fast as we sell them. Also, selling assets to finance the purchase of oil and cheap Chinese consumer products is much better than trying to do without them, especially oil.
Published: July 26, 2007 9:59 PM
RogerM
Can't wait to read the book. The more Austrian econ I read, the more convinced I become that it has great insights for investing. I just finished Hayek's "Prices, Production and Profits" and realized that Austrians could effectively time the stock market by purchasing stocks in capital intensive industries, shifting to consumer goods industries and commodities as the expansion matures, and going to cash/gold near the end of the boom. You can identify the end of the boom because profits are higher than normal, which happens because demand for consumers goods is high but production insufficient to meet demand, so prices rise while wages don't.
Alex, the quote from J. Enoch Powell is great and right on the mark! Thanks!
Robert Blumen's comments on the trade deficit are welcome as well. While it's true that we are selling assets in order to pay for imports, that's not a bad thing as long as we are creating assets as fast as we sell them. Also, selling assets to finance the purchase of oil and cheap Chinese consumer products is much better than trying to do without them, especially oil.
Published: July 26, 2007 10:00 PM
RogerM
Can't wait to read the book. The more Austrian econ I read, the more convinced I become that it has great insights for investing. I just finished Hayek's "Prices, Production and Profits" and realized that Austrians could effectively time the stock market by purchasing stocks in capital intensive industries, shifting to consumer goods industries and commodities as the expansion matures, and going to cash/gold near the end of the boom. You can identify the end of the boom because profits are higher than normal, which happens because demand for consumers goods is high but production insufficient to meet demand, so prices rise while wages don't.
Alex, the quote from J. Enoch Powell is great and right on the mark! Thanks!
Robert Blumen's comments on the trade deficit are welcome as well. While it's true that we are selling assets in order to pay for imports, that's not a bad thing as long as we are creating assets as fast as we sell them. Also, selling assets to finance the purchase of oil and cheap Chinese consumer products is much better than trying to do without them, especially oil.
Published: July 26, 2007 10:00 PM
TLWP Sam
Please do inform me why must holding cash in the long run be considered a serious investment? If someone was storing money in a shoebox or under a mattress then it would mean they want liquidity. If they want high returns then they'd invest in shares. And if they are storing large quantities of cash then that must mean they're rather pessimistic about the short term future. Of course, if someone was expecting the currencies of the world to collapse or saving for the very long term (and not be too concerned about short term liquidy) then they'd be storing gold and silver coins in a shoebox or under the mattress.
Published: July 26, 2007 10:10 PM
Robert Blumen
TLWP: I qualified the holding of cash with "at times". The reason for being out of equities and in cash at times is that stocks have become very over-priced, and you expect them to be under-priced at some point in the future. You preserve your purchasing power by going to cash and waiting so you can buy more shares in the future.
Published: July 26, 2007 10:18 PM
RogerM
TLWP:"Please do inform me why must holding cash in the long run be considered a serious investment?"
By "cash" people often mean a money market account where your earn a little interest. As Mr. Blumen suggested, and based on Hayek's views on the ABCT, you want to go to cash when the stock market, or any other market such as real estate, has increased rapidly. Currently, corporate profits are high, and consequently, the stock market is at record levels. This indicates that we're somewhere in the last stages of the boom. This is a good time to go to cash. Don't worry about trying to catch the top of the wave.
Published: July 27, 2007 10:11 AM
Eduardo
RogerM, I do not agree with your statement that the stock market is at record levels, because you are not considering the efects of inflation.
Please note that if you consider the CPI, you should adjust the max by about 20%. And we all know that the government published CPI does not represent the monetary expansion, which was more than that.
I do not consider the DJIA to be representative of the US stock market. So, I think that it is more appropiate to consider the S&P 500, and since its previous max was 1552 on March 24th, 2000, adding a 20% will leave it at 1862, which is well over the 1555 level that it hit last week.
I am not making a judgement over if the stock market is overvalued or not, just that the current level is not a record one.
Published: July 28, 2007 2:15 PM
banker
It is my understanding that the trade deficit the US has must be financed somehow. Recalling Says Law, goods and services must be exchanged for goods and services. So I ask myself and those on this board, what goods or services are people from the US trading for the level of imports we are currently receiving?
Also noted by someone earlier, one cannot trade future goods because future goods don't exist today. When an entity (company or person) issues stock or debt, they are *selling* a portion of their assets. Since a vast amount of products is coming into the United States from the likes of Japan and China, what are the Chinese and Japanese getting in return today? Moreover, who in Japan and China is getting what from who in the US?
This brings up the central bank role in all of this. The Chinese and Japanese central banks are financing a big chunk of the deficit. Without compounding the complexities of the money multiplier, these central banks are buying US federal government debt. US debt is paid through tax money + tax money comes from the confiscation of assets -> US gov is defacto *selling* private citizen's property to foreigners? And who in China is reaping the benefits of this?
The Chinese central bank is acquiring vast amounts of American wealth in the form of currency reserves. However, recalling Say's Law once more, what is the central bank using to trade for US assets? From my understanding, it appears to be stealing Chinese savings to pay for American assets. Chinese workers/companies export goods to the US, with a portioned of said valued by siphoned off to the central bank via funny money? So the theft is coming from both sides?
Published: July 29, 2007 10:44 AM
David White
banker,
I concur. Moreover, I believe that when (not if) China finally decides that vendor-financing its US exports is a losing proposition (i.e., when the dollar is sufficiently worthless that it stops buying US Treasuries), it will let the yuan appreciate dramatically, much to the benefit of the Chinese people, who will finally be able to afford the things they make instead of exporting them.
On the other hand, China et al. will not be allowed to purchase US assets at what will be fire-sale prices. Why? Because the US government will by then have instituted capital controls, the better to create the EU-like trading bloc otherwise known as North American Union -- http://www.thought-criminal.org/2007/02/09/the-north-american-union-exposed-a-presentation-on-the-destruction-of-america -- complete with an euro-like currency -- http://www.youtube.com/watch?v=6hiPrsc9g98 -- to paper over the collapse of the dollar.
Published: July 29, 2007 11:27 AM
RogerM
I just finished reading Schiff's book and found it interesting and offering good advice, except for the ranting about the trade deficit.
Schiff should read Mises and Hayek more closely, especially Mises's work on the German inflation of the 1920's. Mises repeats several times that trade doesn't not affect exchange rates. The German central banks used the trade deficit as an excuse for the falling value of the mark, but Mises demolishes that argument. Mises flatly states that only excess credit/money created by the central bank can cause the value of a currency to fall relative to other currencies. Trade balances have nothing to do with it!
Schiff advises investors to go foreign until the trade deficit causes the dollar to collapse. This was good advice when the dollar was at record highs against other currencies a decade ago, because the falling dollar value would juice the returns on foreign investments. But now that the dollar has hit bottom, that's bad advice. The dollar will recover against other currencies as long as the US Fed maintains relatively high rates. When it does recover, the climbing value of the dollar will hurt returns on foreign investments.
Also, Mises was referring to relative monetary inflation, not absolute inflation. If the US and Europe inflate at the same rate, the exchange rate won't change. For most of the past half century, the US has inflated less than any other country except Switzerland. The dollar's recent lows have come about because the US has been inflating more than other nations, thanks to Greenspan. If Bernanke keeps his word and keeps interest rates up long enough to bring price inflation under control, you'll see the dollar recovere its value.
Besides, look at a graph of the value of the dollar since 1980. You'll see that the dollar has frequently fallen to near its current value and recovered. Against the Euro, the long term average is about $1.20. The dollar should recover to that level by next year.
Published: July 29, 2007 3:42 PM
Alex MacMillan
RogerM:
Suppose there are two countries in the world and that there are no international capital funds flows. Country A (pesos) produces only winter vacations and imports consumer goods from Country B. Country B (C$)has bad winters. As The incomes of those people in Country B increase, more and more people desire winter getaways in Country A. Country A and B expand their money supplies at the same rate (however defined). Why wouldn't the peso/C$ exchange rate rise, keeping in mind that the exchange rate must always be such as to make the $ and peso value of exports equal to the $ and peso value of imports?
Published: July 29, 2007 5:21 PM
David White
RogerM,
If the government truly wanted a strong dollar -- instead of endlessly mouthing off about it (as is every Treasury Secretary's job) -- then all that would need to happen is for the Fed to raise the Fed Funds Rate. It can't, however, and will instead lower it, as early as next month, in a vain attempt to stave off a collapse of the housing and stock markets.
The dollar hasn't hit bottom, in other words, and will soon crash through 80 on the dollar index, on the way to its (i.e., the FRNs) instrinsic value of zero. Just as Mises knew it would, recognizing that you can only have "trade deficits" in a monetary regime based not on savings-based production but on debt-based credit expansion.
Published: July 29, 2007 5:29 PM
Alex MacMillan
Mark and Gabriel:
Mark: What does "to support enough increase in future production to offset current consumption" mean?
Gabriel: You answered Mark's question (??) by saying, "Investments in capital were greater than capital consumption [wearing out of capital] in 2006." I added the [] comment.
You backed up your comment with figures. There was a increase in the net capital stock (using your data) of $1,056 billion, while the trade [not sure if it's the trade or current account] deficit was $763 billion. What is the relevance of the net capital increase of $1,066 billion relative to Mark's question and to the trade deficit of $763 billion? Are you implying that everything is fine as long as the trade deficit remains less than the annual net investment in real capital, but that if this is not the case then people should worry for some reason?
Published: July 29, 2007 5:35 PM
RogerM
Alex:"Why wouldn't the peso/C$ exchange rate rise...?"
The rates wouldn't change because as the Canuks visit Mexico more frequently, and spend more money on vacations there, the income of the Mexicans will rise and they will consume more imports from the Canuks.
Published: July 31, 2007 9:11 PM
Clayton
While I have not read the book, I suspect Blumen has a lot of the right ideas and some of the wrong conclusions.
Certainly the reviewer seems to nail most of the likely weak spots.
===
Fact: The US is bacially a net non-saver. But, so long as production > consumption, we don't necessarily implicitly create problems, we just limit capital accumulation. I'm not precisely certain how the savings numbers factor in capital depreciation, but companies are profitable so apparently we're replacing that cost as part of the mix. Let's assume for the moment that the US operates at strictly replacement levels (so production = consumption + depreciation). Stats cited by others appear to support this assumption.
People in China are big net savers (both by choice and due to additional government intervention). They invest their capital where it produces the greatest return on investment.
Obviously, economics demands that this return is the same everywhere, but that means that, some of the time, it's better to invest in the US than elsewhere (even though the US is internally only operating at replacement levels).
Capital flows in.
Some might point out that we import consumer goods... Even if we imported 100% consumer goods, we produce producer goods internally. Economically, this is equivalent to consuming our own consumer goods and importing producer goods (except that the whole unskilled labor thing makes the opposite more efficient).
All of this isn't necessarily a problem so long as:
-Increasing demand for our labor increases real wages (driven up by growth in the capital stock per captia)
-Our businesses profit by "managing" foreign captial and taking a cut of the profits of that capital
Both seem reasonable
Of course, this is all independent of increases in productivity that (on aggregate) allow us to get more goods out of less labor (the ultimate goal of productivity). This can even allow a fixed capital stock to produce more "profit" (and thus grow in value) despite some claims herein to the contrary.
===
Where I suspect the book is right is that it realizes that increasingly the capital is more productive outside the US (part and parcel to higher interest rates). Less capital inflows will create lower productivity and wage growth. It also reduces the ability of our businesses to take their "management fees" out of foreign capital.
Equity is ownership of the "management fees" of both internal and external capital. As labor is scarce, wages obviously are also implicitly tied into this relationship (productivity of labor is not independent of capital levels). If people assume a certain level of growth and that doesn't come, they over-value both equities and more importantly gross lifetime-household wealth. As a result, they overspend their means.
This reallocation of capital could lead to a significant "correction" that impacts the standard of living of Americans.
===
Exchange rates may influence these factors (obviously, having the Chinese subsidize our capital imports subsidizes/inflates the various profit/wealth centers). However, monetary policy responds to fundamental economic forces (factoring in, obviously, the number of monetary units) and, despite stickiness, cannot generate lasting structural changes. Even Austrians accept that the cycle includes the necessary "corrections" to make this statement generally applicable.
===
Without reading his whole book, the basic ideas are not unfounded. However, certain emphasis (and the severity of his argument) seem fallacious -- but probably excellent marketing tactics.
Published: August 8, 2007 4:04 PM