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A Coat of Paint


Over the weekend Mr. Greenspan has all but declared victory in his battle against the threat (real or perceived) of deflation. Right on cue Federal Reserve Governor Bernanke and Treasury Secretary Snow both reassured the public that the risk of a dollar "crisis" was quite low. They reminded everyone that although the dollar has fallen quite a bit (maybe to 'crisis" levels) against the euro, it has not done so against all currencies. At the risk of sounding repetitive, I thought it important to remind our readers of something I pointed out late last year.

First of all the only reason that the dollar has not fallen even more than it has and created what Mr. Bernanke and Mr. Snow would qualify as a crisis is the fact that China and Japan are intervening by unprecedented amounts to keep their currencies weak. Basically Europeans are no longer willing to buy our debt, while for some uneconomic reason, the Asian countries are.

Even so, broad measures of the dollar have fallen around 15% over the last six months. This means that while U.S. companies are making more dollars, those dollars are worth a lot less to the rest of the world. In other words, even though companies are making more dollars, their wealth as measured by the ability to purchase things around the world has actually decreased.

This is the same for any U.S. consumer as well: although the paycheck in dollars is higher, the ability to purchase goods around the world is lower.

Meanwhile not one cent of U.S. public debt is being paid back. If one looks at the relative flows of currencies, the story that they are telling is that the only ones left really willing to buy our debt are China and Japan.

Someone mentioned to me that U.S. treasuries have been declining because of the economic recovery: investors are leaving safety for riskier financial assets. This certainly is at least partially true, but remember that there is another possibility: maybe the credit of the U.S. is declining. Maybe the world is choking on dollars.

I have been looking for a decline in the dollar to begin to affect treasuries at some point. There is finally some positive correlation to this, but it remains to be seen as to cause and effect. If this continues and becomes more pronounced, it may indicate that something very different is going on than what our Federal reserve is telling us. Confirmation of that will come if and when our economy slows down with no commensurate recovery in treasury prices.

One thing I am certain of: without China's and Japan's help right now, our economic leaders would not be sounding nearly as confident.
No positions in stocks mentioned.

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