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Minyan Mailbag: Fannie, Freddie and The Dollar


What effect did the GSE bailout have on the buck?

The following appeared on the Buzz earlier today and is reprinted here for the benefit of the Minyanville community.

Lower Oil's Harsh Reality

Lower oil is giving hope to the bulls. Once again let's look under the hood.

The reason for lower oil right now is that China's imports have fallen drastically since the beginning of the Olympics. Perhaps it stock piled beforehand, or more ominously, perhaps its economy is rapidly slowing and oil demand is falling permanently. But oil is falling as economic weakness is taking hold in Asia and thus, the dollar is strengthening. As I pointed out, the dollar strength at this point in the cycle (secular change) is not a positive. Whatever pick-up in exports occurred as a result of a lower dollar will not happen. Oil must fall a long, long way to offset deteriorating economic weakness due to the huge debt that is being written off.

The credit crunch first hit financial companies. As they curtail lending this hits the consumer who can no longer lever up and substitute increasing debt for income. This is reflected in the jump in the savings rate for the first time in decades from zero (negative) to a positive 2.5%. As the consumer buys less, companies start to feel the pinch. They can't pass on cost increases. The relationship between PPI input prices and PPI finished goods (margins) has deteriorated to the point that profits are being hit hard… first in financials and then next in consumer discretionary. This is where lower oil prices might help, but the ratio has deteriorated so much it will take a major break in oil to have any material effect.

From my perspective we are now just starting to see the credit crunch affect cyclical companies. This will be the next leg of deflation.

Risk is high.

But The Yen?

Mr. P,

You posted today you think a secular shift has occurred favoring a strong dollar. Earlier this year, in a 'conversation, with Toddo, I thought you had the bulk of your assets in Japanese bonds, as you expected a strong Yen. Do you believe that the Yen and the Dollar can/will strengthen together?

I ask because I have long believed the Yen would be an excellent vehicle to play the unwind of the 'carry trade' and some debt destruction. I also have recently been picking some up the last few days.

Minyan S


The strength in the dollar I think is for all bad reasons, caused by deflationary pressures: the part of the money supply due to derivatives and asset backed paper (a lot of off-balance sheet stuff) is shrinking. This destroys dollars and makes them dear. Oil going down is also relatively strengthening the dollar as oil is still priced in dollars. Oil is going down due to lower demand.

This is all temporary. How long it lasts I don't know… could be a year, could be days. It depends on government intervention.

The next and only tools left to government is direct intervention like fiscal policy and nationalization of certain parts of the financial system. That is hyper-inflative: that will crush the dollar relatively. We don't know where, when, or how that will begin. As I said it could be years or days.

The important thing is to be patient, to understand the huge dynamics at play here. To understand that this is a secular change.

The yen is a long term situation: I want to have my assets denominated in the currency where the money supply has a high amount of savings. This will offset massive hyper-inflation that I believe the U.S. government will eventually attempt. Whether or not the dollar rallies 10 or 20% relatively is not significant to this overall situation.

At the bottom of it all, savings are going to be very valuable. Make sure you have some.

Caught on the Dollar

Mr. Practical,

I've been caught off base by the strength in the dollar. I assumed that the market would realize that the country was basically broke. With the economy slowing down and our need to finance the banks and brokerage community, the budget deficit has to increase significantly, doesn't it?

Thus, we are going to have to borrow a lot more. Shouldn't that cause either rates to rise here and/or a lower dollar?

Minyan Duke


Several weeks ago Ben Bernanke came out and starting talking a strong dollar. I believe this was due to pressure from foreign lenders to not lower rates again, else severe repercussions. This is described in my Pin Prick article from long ago.

So that was key to showing the Federal Reserve is trapped. It signaled to the market that some form of deflation would be accepted by the Fed in order to appease foreign lending to U.S. by other central banks (the market gave up lending long ago). There is a short term market that reacts no matter what the long term implications. The dollar became relatively stronger because the market realized that the Fed couldn't destroy it in the short run.

But that doesn't mean we have the strength to do the right thing for long. Soon pressures will be huge to do something more…and they already are. The bailout of Fannie Mae (FNM) and Freddie Mac (FRE) was accepted as necessary by foreign lenders, but it doesn't mean that it isn't a precursor for dollar destruction going forward.

That destruction is likely to come in the form of fiscal policy and partial nationalization: the government creating dollars (debt) and directly buying assets with it.

Mr. P
Position in FNM, FRE.
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