Quiet on the surface, anything but quiet underneath. And “over there”? Oh, my.
The most important single datum: The Treasury this week sold at auction $70 billion in new long-term bonds for the first time in six years without the Fed as a QE buyer. The auction was effortless, the yield on the 10-year 2.3 percent Monday, 2.35 percent Wednesday, and today just under 2.33 percent. Mortgages have held slightly above 4 percent.
The world is hungry for U.S. paper, bonds or stocks, trying to get out of whatever currency it holds (except Swiss francs, the ultra-safety play) into dollars. And it is very nearly the whole world. Only China is maintaining its dollar peg, but everyone assumes it will have to devalue as well.
The linkage in all currencies at the moment begins with the U.S. economy, easily in the best shape of all, no matter how poor it feels to 70 percent of our citizens. The National Federation of Independent Business’ small-business survey has been stuck in a Great Recession trench, but this year it’s out for real — not healthy, but out. U.S. retail sales managed a modest 0.3 percent increase in October after September’s contraction.
U.S. GDP is growing on a baseline of 2.5 percent, stripped of distortions from inventories and trade. The eurozone overnight announced third-quarter results: up 0.2 percent after the 0.1 percent second quarter. The London Telegraph on China (the Brits for old reasons are still well-connected in Asia): Producer prices have fallen for 32 straight months, its CPI 1.6 percent and falling versus 3.5 percent target, and its actual GDP growth probably less than 5 percent.
Brazilians, Russians, euro-Europeans, non-euro Europeans (Swedes, Danes, Dutch, Czechs …), Brits, Koreans … all have good reason to sell domestic money and buy dollars. The linkage: Deflation is spreading outward from the worst-managed, a dead heat between Japan, Europe and China.
Deflation and even subnormal inflation are fatal in a debt-soaked world. Debtors must pay interest and principal in money more valuable than they borrowed, and can’t borrow new funds. The remedy understood long before the dawn of central banks (circa 1875): Chop official interest rates and print money until inflation is restored, aided by your weakening currency. The alternate or companion remedy is fiscal: Borrow and spend. But the Krugman mirage is foreclosed today by ruinous sovereign debt.
A currency weakened by printing should make your exports more attractive to others, and make imports more expensive, which should … should … push domestic inflation up and out of the danger zone.
Today that ancient strategy is failing. If the fundamental global problem is excess production and excess labor, those who devalue get this disastrous reward: Higher import prices raise domestic costs, but not incomes. Exactly the same effect as an oil “price shock,” self-inflicted, underway in Japan right now.
Another small problem: If everyone devalues at once, their relative positions do not change. Except versus the U.S. and the buck. We have precedent for this situation: the 1997-’98 “Asian Contagion.” At its feverish peak, Russia defaulted on its bonds, and hyperleverage by some math wonks at nobody-ever-heard-of Long Term Capital Management nearly collapsed the financial system.
In 1997 the Fed misunderstood. It was terrified of an unstoppable global recession, and cut the Fed funds rate from 5.5 percent to 4.75 percent. Greenspan, Summers and Rubin made the cover of Time as the “Committee to Save the World.” Few people understood that the flood of global cash to the dollar was an enormous stimulant here, and the Fed’s rate cut just blimped more gas into the stock bubble.
Today I’m not so sure the cash flood will be as beneficial. We, too, suffer from incipient wage deflation. But, short of starting a trade war with tariffs, we have no way to keep the world from swamping our lifeboat — if that’s the correct analogy.
The Fed today is struggling. It sees conditions precedent to an overheated labor market, but a tsunami of deflation as well. Its threats to raise rates just make the currency contagion worse. Better to cork it for a bit, as the Bank of England has done.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
