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Boneheads, Iraq and the Artificial Dollar - John Mauldin'sWeekly E-Letter
From: Dave Farber <dave () farber net>
Date: Sat, 29 Mar 2003 13:23:51 -0500
------ Forwarded Message From: "Faulhaber, Gerald" <faulhabe () wharton upenn edu> Date: Sat, 29 Mar 2003 13:20:16 -0500 To: Dave Farber <dave () farber net> Subject: RE: Boneheads, Iraq and the Artificial Dollar - John Mauldin'sWeekly E-Letter I'm glad somebody was willing to invest lots of time and effort debunking this oil-currency myth. Glad to have one journalist who actually appears to know something debunk another, who actually appears to know nothing, so completely and thoroughly. Nice work, John Mauldin. -----Original Message----- From: Dave Farber [mailto:dave () farber net] Sent: Saturday, March 29, 2003 12:42 PM To: Faulhaber, Gerald Subject: FW: Boneheads, Iraq and the Artificial Dollar - John Mauldin'sWeekly E-Letter ------ Forwarded Message From: Gordon Cook <cook () cookreport com> Date: Sat, 29 Mar 2003 12:33:07 -0500 To: dave () farber net Subject: Fwd: Boneheads, Iraq and the Artificial Dollar - John Mauldin's Weekly E-Letter This is a much more detailed analysis of why the Geoffrey Heard letter is a crock
To: cook () cookreport com Date: Sat, 29 Mar 2003 08:13:17 -0600 Reply-To: <johnmauldin () investorsinsight com> Sender: <johnmauldin () investorsinsight com> From: "John Mauldin and InvestorsInsight"<johnmauldin () investorsinsight com> Subject: Boneheads, Iraq and the Artificial Dollar - John Mauldin's Weekly E-Letter X-Mailnum: 1056258 MIME-Version: 1.0 Status: U Thoughts From The Frontline John Mauldin's Weekly E-Letter Boneheads, Iraq and the Artificial Dollar by John Mauldin March 28, 2003 On Boneheads, Iraq and the Artificial Dollar Central Banks Wave the White Flag As the Dollar Churns The Artificial Dollar The Competitive Currency Dance A Quick Look at the Economy The past two weeks I have had so many people email me an article by one Geoffrey Heard of Melbourne, Australia that I am going to comment on his nonsense. Because it is so wrong and yet his arguments seem so seductive, it offers an excellent opportunity for us to learn how world currency transactions really affect the price of gold and oil and other commodities. Warning: I am taking off my gloves in this letter. This is one of the more boneheaded pieces of conspiratorial economic garbage that I have read in quite some time. I normally don't respond to such ranting, but because it is seemingly being read and repeated in a lot of places, it deserves some attention. Basically, his thesis is that the United States (and Bush) is invading Iraq to insure that they will still stop selling their oil for euros. Bush and the American elitists he represents are apparently afraid that all of OPEC will want to convert to euros. To quote: "In 1999, Iraq, with the world's second-largest oil reserves, switched to trading its oil in euros....Iran started thinking about switching too; Venezuela... Russia...The greenback's grip on oil trading, and consequently on world trade in general, was under serious threat. If America did not stamp on this immediately, this economic brushfire could rapidly be fanned into a wildfire capable of consuming the U.S.'s economy and its dominance of world trade." "It is the biggest grab for world power in modern times.... If America invades Iraq and takes over, it will hurl the EU and its euro back into the sea and make America's position as the dominant economic power in the world all but impregnable.... This debate is not about whether America would suffer from losing the US dollar monopoly on oil trading-that is a given-rather it is about exactly how hard the USA would be hit. The smart money seems to be saying the impact would be in the range from severe to catastrophic. The USA could collapse economically.... The key to it all is the fiat currency for trading oil... Under an OPEC agreement, all oil has been traded in US dollars since 1971 (after the dropping of the gold standard) which makes the US dollar the de facto major international trading currency. If other nations have to hoard dollars to buy oil, then they want to use that hoard for other trading too. This fact gives America a huge trading advantage and helps make it the dominant economy in the world." Heard goes on to write about other US offenses, making clear that he understands the reasons for the vast conspiracy in which Bush and company are engaged. He clearly does not like the current US policy and looks to blame any and all world problems on Bush. Conspiracy Theorists of the World, Unite! First, let's look at his first thesis: if OPEC began to sell oil for euros, it would doom the dollar and be a catastrophe for the US: "The USA could collapse economically." You could make a case that in 1971 the oil for dollars deal was good for the US, but it was not some conspiracy or "deal." At the time, there was no other major currency with enough scope and supply to function as a major trading currency. The euro did not exist. The German mark and British pound did not simply have the supply of currency necessary without stretching the currency markets. That was a period in which central banks had some measure of short and medium term control over the valuation of their currencies. By working together, they could establish a price range between currencies. Then came 1992. The foreign currency markets had grown dramatically, and central banks were struggling to control their currencies. George Soros and the legions of traders who were investing/betting in the currency markets decided the pound, among other currencies, was over-valued, and were shorting the British pound. Legend has it that a reporter came to him and asked him what he was going to do because the Bank of England was going to spend $30 billion pounds defending the value of the British pound. Supposedly his answer was, "What are they going to do in the 30 minutes after that?" $30 billion pounds was about 30 minutes of trading on the currency exchanges at that time. The point was that central banks no longer had enough money to support a currency. To support a currency you have to have foreign deposits in order to buy your own currency. While the bank of England could print all the pounds they wanted to, they could not manufacture dollars or marks or yen. Those currencies had to come from actual trade surpluses, which England did not have at the time. ADVERTISEMENT Wall Street's loss is your gain! The market lost 28.9% over the last 6 months. But Dennis Slothower's "Stealth Stocks" -- companies overlooked by Wall Street and the media -- returned profits of 44.67% ... 49.29%... 52.89% ... 93.01% ... 111.71% ... even 258.13%. "My Stealth Stocks don't make news," explains Dennis. "They just make money." For a free report on 5 new "Stealth Stocks" poised to double in the next 12 months -- including a red-hot medical equipment company with an astounding 413.4% earnings growth -- <http://www.investorsinsight.com/asp/t.asp?a=135r1ti1xu1056258v>find out more. Central Banks Wave the White Flag Within a few weeks, what I regard as one of the more remarkable and important op-ed pieces of the last half century appeared in the Wall Street Journal. It was an article by Walter Wriston, chairman of CiticCorp and the ultimate insider: Council on Foreign Relations, Tri-Lateral Commission and confidant of presidents and world leaders. In it, he basically waved the white flag. We were in a brave new world where currencies were no longer controlled by central bankers but by currency traders. I remember reading it and recognizing the truth which it contained. I, for one, was happy. In essence, the ability of central banks to manipulate their currencies for more than a short time was gone. Even acting in concert, central banks do not have the real ability to affect the markets for more than a few days. The most they can do is threaten, which keeps short term traders nervous, but currency trades back up like flood waters at a dam, eventually pouring over. Today, Chuck Butler, currency trader at Everbank tells me the world currency markets trade $1.2 trillion a day. That is almost one half a quadrillion dollars a year. To provide some perspective, the entire US economy is "only" $12 trillion or so. The total value of oil trades a day is a drop in the bucket compared to the currency markets. If OPEC wanted to be in euros all they have to do is convert to euros. You could price oil in terms of any currency, but those who sell must do something with the dollars or yen or yuan or pesos they get. After the money is in an OPEC bank account, they can do anything they want with it. If OPEC decided they wanted to price oil in euros, it would make no difference to the US price in dollars. It is supply and demand, and currencies are extremely liquid. Heard writes "If other nations have to hoard dollars to buy oil, then they want to use that hoard for other trading too." In light of the liquidity in the currency markets, this is a stupid statement. You could "hoard" any major currency (yen, pesos, euros, pounds, won, renminbi, etc.) and when you want to convert it into dollars to buy oil you can do so instantly and with almost no transaction cost. A country or business will keep its reserves in whatever currency it thinks is the best at the time and then convert for the sale. There is no "hoarding" of dollars, unless that is the currency the various central banks or businesses want to use. As an example, let's look at gold. Gold is in a great bull market, right? On July 1, 2001 gold was 265, and today it is around $330. That is a $65 rise for about a 25% gain. On that same day, the euro was $.8378 and today the euro is $1.07. The euro has risen almost 30%. Which is the bigger bull market? Furthermore, if you live in Europe, there has been no gold bull market since July, 2001. Gold, in terms of euros, is actually down slightly, depending on what day you look at gold and currency prices. On July 1, 2001 you got 316 euros when you sold an ounce of gold. Today you only get 299 (at $1.07). The same applies to oil. In the US, we have watched as oil prices go through the roof. Depending on what period you use, oil is up only slightly in Europe. Is that because OPEC loves the French? Of course not. It is entirely because the dollar has dropped against the euro. If oil were priced in euros, the results would not be any different. The price would have risen in the US and been almost flat in Europe. The reasons for the drop in the dollar have nothing to do with Iraq or oil. We will discuss the real reasons a bit later. Look at it this way: there is x amount of oil available for sale on any given day. It will go to the highest bidder. If someone from Europe wants to buy oil, in reality he is paying in euros. The conversion to dollars is transparent to him. In large amounts, it costs almost nothing to convert to dollars or pounds or any currency. Oil is no different than wheat or sugar or any other commodity. It is supply and demand that determines the price, and the currency used for the transaction has nothing to do with it, as long as it is liquid. To claim, as Geoffrey Heard does, that the dollar would drop because of oil being priced in euros is absurd and shows a complete lack of understanding of how the currency markets work. Further, to suggest that "If America invades Iraq and takes over, it will hurl the EU and its euro back into the sea" is equally absurd. What if America decided to invade Australia to take over its wheat crop? Would that hurl Canada and its dollar into the sea? Heard's thesis is based upon the presumption that the US wants to maintain a strong dollar, when in fact the clear leaning, if not actual private preference, at both the Treasury Department and the Federal Reserve is to allow the dollar to drop. While the Bush administration gives lip service to a strong dollar, they have also made it clear that they do not intend to intervene to support it. "Let the market work" is the mantra. A falling dollar helps the Fed control deflation. A gradually falling dollar works to our benefit by making our products cheaper on the world markets. It allows US producers to compete with foreign companies for the American consumer dollar. It helps stem the deflationary tide. And it helps lower the trade deficit, as it makes imports more costly and helps our exports. Further, Heard's thesis assumes the US is capable of controlling the value of a dollar. It is not. The world currency markets are far bigger than the US Federal Reserve. The only unilateral power a central bank has is the ability to destroy its currency by printing too much of it. Oh, I suppose the Federal Reserve could reduce the money supply and the supply of dollars and drive the dollar up. But classic economic theory says you can control the quantity of a product (in this case the dollar) or the price, but not both. Reducing the money supply would currently throw the US into a severe deflationary recession and possibly lead to a world-wide depression. That is not a policy that is likely to be pursued. As the Dollar Churns With that as background, let's look for a moment at some of the seismic changes which are happening in the world currency markets. I am going to suggest to you that one event leads to another which leads to another and the result is not what you are hearing in the mainstream press. The first thing to notice is the huge US trade deficit, currently in excess of $500 billion. This is now close to 5% of GDP, and as noted this time last year, in every case in history when a country reaches a trade deficit of 5%, a serious currency correction follows. As long time readers know, a 20-30% drop in the currency does not bother me. The US went through such in the 1980's, and life seemed to go on just fine, thank you. The Artificial Dollar The dollar is artificially high. By artificial, I mean the following things: first, the rest of the world, and especially Asia, is hooked on selling products to the American consumer. If prices were to rise 30%, we would buy less of their products and more of our own. If they sell less, their unemployment rises and profits drop. For now, they are willing to take dollars because it keeps their factories going. They convert those dollars into local currency or other currencies. Secondly, there are those who hold dollars because it is better than their local currency. Physical dollars are desired in many Latin American and African countries, and other parts of the developing world. The clear pattern is that the dollar is a better value than the local currencies. Could the euro become as popular a currency? Sure, but then there would be two choices, not an abandonment of the dollar. Will it be more popular than the dollar? In some countries, yes, especially those closer to the Eurozone. But the primary driver for such holdings is not to get the best performing currency, the euro or the dollar, but to have a currency which is not their local currency, which their local governments continually inflate and debase. Third, it is obvious that if we were not the reserve currency of the world, the dollar would not be as high. The dollar would have less buying power. Foreigners look at that buying power and are often jealous, seeing it is part of American hegemony. But it cuts both ways. An artificially strong dollar has meant that our manufacturing base has slowly been eroding as more and more jobs leave the US for cheaper production climates. There is no free lunch. As I noted one year ago, Morgan Stanley projected that a 20% drop in the dollar against the euro would knock 1% off of the GDP of Europe, and it looks like it is doing just that, as it hurts their sales to us and makes their goods and services more expensive to the rest of the world. If the dollar were to drop another 10% or go to $1.25 you will hear screams and moans throughout Europe, as business would have to compete against much cheaper production from not only Asia but from the US. A rise to US$1.25 euro means the price of products made in Europe would have risen 50% in terms of dollars over a period of just a few years. This will give the US and Asia a huge advantage in selling products and services to Europe and a major competitive advantage in the rest of the world. If European businesses are already having problems (and the statistics suggest they are) then this would be even more devastating. What could Europe do? They could ask for an increase in tariffs, but this would start a trade war which they would lose, and could possibly trigger a world-wide recession. It would also contravene a lot of treaties they have worked very hard to get signed, and also cause a major split within the European Union. This is not a likely scenario. The more likely effort will be to get the Chinese to allow their currency to float against the dollar. Today it is pegged to the dollar, which means a fixed amount of Chinese currency always equal a dollar. If the "peg" is taken off, the Chinese currency will rise, thus making their products more expensive and European (and US) products relatively more competitive. The rest of the Asian Tiger countries will be able to let their currencies rise along with the Chinese renminbi. None of these countries are against a stronger currency as long as they to do not lose competitive advantage against each other. Foreign products will cost US consumers more, we will buy less and will be able to sell more of our products and the trade deficit goes down. (This whole process could take a decade or longer.) John Mauldin <mailto:johnmauldin () investorsinsight com>JohnMauldin () InvestorsInsight com Copyright 2003 John Mauldin. All Rights Reserved. <http://www.investorsinsight.com/newstofriend.htm?a=135ti1xu1056258v>Send to a Friend | <http://www.investorsinsight.com/asp/p.asp?a=135ti1xu1056258v>Print View | <http://www.investorsinsight.com/contactjohn.htm>Click Here Contact John Subscriber Services You are currently subscribed as cook () cookreport com. To Change your subscription or unsubscribe, go <http://www.investorsinsight.com/subscriberservices.asp?a=135ti1xu1056258v>here
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- Boneheads, Iraq and the Artificial Dollar - John Mauldin'sWeekly E-Letter Dave Farber (Mar 29)