Re: Sobering Thoughts on Export Policy

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

William F Hummel wrote:

>
> One might ask why foreigners continue to accumulate dollars since
> they can only be spent on dollar-denominated goods or assets.

Because the value of their own currencies depends on the amount od dollar reserves
they hold.

>
> Obviously it is because they find their dollar holdings more
> desirable than those in their own currency.

Not quite, the obvious is that they have no choice. Japan is a ver clear example.
They hold so much dolar reserves that if the dollar were to fall, Japan would
suffer from both ends of the candle, a rising price for Japanese exports, and a
fall of Japnese holding of dollar asset values

> In spite of all its
> problems, the U.S. remains the most stable and prosperous nation
> in the world.

Even Greenspan admits that this "stable and prosperious state" has been achieved
from conditions that led to financial crises in the rest of the world, what
greenspan calls the "salutary effect" in his testimony to Congress after the Asian
Crisis of 1997.

> Financial prudence leads many foreigners to prefer
> a mixed portfolio, keeping some of their investments in the U.S.
> Like deposits in a bank, they are willing to accept lower returns
> on their dollar assets because of their relative safety.

This sentence is inoperative ever since the emergence of the derivative markets in
currencies.

> The US has the largest industrial production by far of any
> nation, and therefore no shortage of goods to export.  How much
> is bought is largely a matter of price.

What is price?
Price is a reflection of the conditions behind a transaction, not the cuase of it.
Prices do not exist in a vacuum.

There was a time when markets existed because some participants needed things
others are willing to sell at a price.  Out of this fact, the theory of marginal
utility has been constructed to analyze how markets
work.  Ford did not consider himself a capitalist.  He was an entrepreneur and he
despised bankers,
particularly investment bankers.  Ford created an industrial enterprise that had
financial value, not just financial value from market transactions. The consumer
who bought a Ford car would most likely feel
comfortable in buying Ford shares.

But under finance capitalism, markets operate very differently than they did under
industrial capitalism.  Investors who buy Ford shares may never buy a Ford car, nor
have they the slightest interest in Ford
cars.  This difference is most observable in the relationship between price and
value.  There was a time when market transactions  were conducted between end users
and producers, in which case, price
parallels value.  That is, the higher the value, the higher the price. But under
finance capitalism, the market is dominated by financial transactions driven by
non-end user profit incentives: derivatives,
options, swaps, etc., where the end users are basically on the sideline as a
notional value.  Take for example, the price of a company's share. When share price
rises without a corresponding rise in fundamentals, it translates into a lowering
of value of the stock, expressed in the higher price/earning ratio or price/book
ratio.  Price thus moves in the opposite direction of value.  This is because
markets are now largely driven by technical analysis. There was a time that a buyer
must have a seller to complete a transaction. But with structured finance, both
buyers and sellers can be unknown until the contract expires in the future. The
amount of profit and loss is also undetermined until the contract expires in the
future.  Thus markets no longer operate on information, symmetric or not, but on
predictions, speculations or
risk-taking (read management).

Although in a way, technical analysis is not totally detached from fundamental
analysis in investing, today's financial markets are mostly driven by technicals.
Technical analysis involves research into the
demand for and supply of securities, options, mutual funds, commodities and other
financial instruments based on trading volume and price studies, using charts
generated by computer programs to identify and
project price trends in a market index, security, fund or future contract.  This is
also true for the commodities markets. Most tech analysis is done for the short or
intermediate term, but some are done
to predict long-term cycles.  Unlike fundamental analysis, technical analysis is
not concerned with the financial position of a company or a sector. It is mostly
concerned with A/D (Advance/Decline) lines:
measurement of the number of stocks that have advanced  and declined over a
particular period to identify bullish or bearish trend; moving averages of security
or commodity prices constructed on a period as short as a few days or as long as
several years.  Moving Average Convergence/Divergence (MACD), usually shown as a
histogram, is a TA oscillator that measures overbought or oversold situations, with

positive or negative breakouts.  Stochastics Index is a computerized TA
tool/oscillator using MA and Relative Strength techniques (rate at which a stock
falls or rises relative to other stocks in either a falling or rising market).
Buy/sell decisions are affected by such phenomena as ascending tops; dips, double
bottom, elves, fall out of bed, flag, flurry, gap, head and shoulder, new high/new
lows, put/call ratio. etc.

Fundamental analysis in economics describes research of such factors as interest
rates, GDP growth rate, inflation rate, unemployment and inventory to predict
trends in the economy.  For investment, FA analyses the balance sheet and income
statements of companies in order to forecast their future stock price movements.
FA considers past records of assets, earnings, sales, product pipelines, management
makeup and strategic plans to evaluate a firms prospects to determine if a
particular stock or sector is undervalued or overvalued at a given price.

Technical analysis is what makes price bubbles possible, particularly in the last
decade, because the price of a stock is justified by the buyer's expectation of a
future rise.  The rule of behavior is to buy after the bottom and sell near the
peak, even for the short term, profiting from volatility. Market-neutral trading
strategies are widely used to squeeze wealth out off both bull and bear markets.
Greenspan's acknowledgment of the wealth effect on a booming economy through the
1990s is an example of a TA bubble's effect on fundamental analysis in economics.
In technical analysis, there is little asymmetrical
information.  Most market participants have equal access to the same information on
market movements. To be sure, the models are all different, but that is a matter of
insights and judgment, not information.  All have the same information, but
everyone makes different conclusion from the same information, often based on
experience from a paradigm that may or may not hold and on ideology that may or may
not be valid.

In a globalized economy, prices are of course a function of foreign exchange
rates.  The financial media routinely reports on returns in different markets
around the world in both dollars and local currencies.  Often a gain in dollars
would mean a loss in local currency or vice versa.  The impact of foreign exchange
rates on prices is direct and fundamental.   Strong or weak currency policies are
mostly politically based and market insensitive.

The term TED in foreign exchange market refers to Treasuries over Eouro-dollars.
The TED spread is the difference between interest rates on Treasuries and
Eurodollars.  Traders in futures markets actively
trade the TED spread, speculating on the difference between Treasuries and
Eurodollars widening or
narrowing. A narrow spread indicates confidence in financial markets.

The price/book ratio is used by investors to judge if a stock is over or under
valued. Conventionally a high price/book ratio of 3 or over is categorized as a
growth stock (betting on future earnings).  A company
whose stock sells under book value is a target for take over.

The Price/earning ratio is also used.  A P/E ration of 20 and above can only be
justified by young, fast growing companies.  The S&P 500 has an earning of $20 per
share. At a 15 multiple, it would be at 300 instead of 1089.98 (10/15/01).

There are indications that the rush to make markets more efficient is whatpushed
the economy into its current fix. In nuclear warfare, the slowness of bombers are
considered stabilizing because they can be
recalled.  Hyper efficient markets are in fact dangerous.  It can plunge the world
into a sudden liquidity crisis, as the LTCM fiasco almost did.

US Treasuries serve a more complex function than merely targeting the Fed funds
rate.  US treasuries
are crucial to the repo market.  Last Oct 4, 2001, Thursday, the Treasury took the
unprecedented move of holding an unscheduled auction of 10 year bonds to avert a
breakdown in the repo market, a little known but critical part of the financial
market.  I have posted on the repo market time bomb a couple of years ago.  The
repo market is where Treasury securities are borrowed and lent. It is crucial to
the
operation of the Treasury market because it provides the funds that dealers need to
pay for the securities they have bought and, therefore, helps keep trading running
smoothly. The dealers use the securities they
have bought as collateral on loans and agree to repurchase the securities at a set
date. With the prospect that securities might not be returned, both dealers and
large investors have become unwilling to lend
them in the repo market.  Both the WSJ and the NY Times reported on it.

A shortage of specific Treasury issues since 9:11 was making it progressively more
difficult for the repo
market with a volume of $500 billion a day of short term lending, to function
normally. The repos market is the core of the money markets. It is through the repo
market that the Open Market Committee targets short term rates.  The LTCM crisis
was also centered around the repo market.  Repo "fails" and fear of them prompted
holder of bonds, particularly foreign Central Banks, to refuse to lend them,
exacerbating the shortage. When the equity markets reopened after 9:11, the sharp
drop of prices forced investors to flee to bonds.  An average of $45 billion of
fails in the second quarter shot up to $400 billion for the week ending Sept 12,
$1.4 trillion for the week ending Sept. 19.

The global economy is in an extremely precarious state.  The solution will not come
from more efficient markets.

> So how soon will
> (foreign) exporters demand payment for their goods in their own
> local currencies, thereby ending the "dollar hegemony"?
>
> William F Hummel

The term dollar hegemony was coined by Greenspan (with consideerable pride, in
connection with US financial hegemony in official Congressional testimony), not me.

No one knows when the world will wake up to reality.  One thing is certain. When it
happens, it will hapen in a matter of a couple of hours.

Henry C.K. Liu