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Joseph Stuber
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Joseph has been an analyst, investor, and student of economic theory; money and banking; and statistical methods for evaluating and implementing risk/reward trading algorithms since 1972. Joseph is also an occasional contributor to financial publications and his essays are frequently cited by... More
  • As The Bernanke Era Comes To An End A New Global Paradigm Is Almost Certain But Few See It Coming 43 comments
    Sep 1, 2013 4:44 PM

    Many of us wondered if the Jackson Hole Summit this year would offer anything of significance with Bernanke not in attendance. The primary focus for most was the hope that we would we get some clues on the matter of the Fed's timing on pulling back on the controversial QE program?

    Surprisingly we did indeed get something of significance coming out of the Jackson Hole Summit but it was not what most expected. The following quote is the opening statement in a Reuter's article entitled Central bankers debate risks from withdrawing global liquidity:

    Global financial stability is at risk as central banks draw back from ultra-easy policies that have flooded the world with cash, because emerging markets lack defences to prevent potentially huge capital outflows, top officials were warned on Saturday.

    The Fed's talk of tapering is real and relevant to investors but it is only of secondary importance as far as this article is concerned. The primary focus of this article is whether or not the US dollar will remain the world's reserve currency. It is a very complex and highly controversial subject that gets almost no play in the press but an enormous amount of focus behind the scenes.

    The harsh truth is that we have reached the end of an era and it is blatantly clear to those of us who understand the subject that Keynes was right when he stated at the 1944 Bretton Woods conference that a sovereign currency would not work as the world's reserve currency. The reasons are multi-faceted and complicated to say the least and I am not sure I can explain the complexity of the issue in terms the average investor will understand but at the request of a number of my readers I am determined to give it a try.

    Before I venture into the subject - a highly controversial and divisive subject to say the least - I think it is important that I open up to my readers and tell you where I stand on matters political and economic. The subject discussed here is - as I stated - divisive and controversial and I don't want anyone to mistakenly assume my comments and views on this subject are informed by a socialistic or anti-American perspective as nothing could be further from the truth.

    I am an avid capitalist and a proponent of a smaller and less intrusive government. That said, I also recognize that anything taken to its extreme is destructive and counter-productive. In other words I believe the government must have a role in reining in those who abuse the privileges afforded them in a capitalistic society.

    I tend to think Henry Ford had it right. Henry Ford's genius was in part recognizing the need for an affluent middle class. He recognized that it was the masses that provided the fuel for a strong and growing economy. If he paid his workers enough they could buy what his company produced - automobiles - and in so doing all came out winner.

    The world Henry Ford helped define - a world where middle class affluence was the objective - has been destroyed by the very thing that made it possible in the first place, free market capitalism. John Dalberg Acton's famous quote - "Power tends to corrupt and absolute power corrupts absolutely." - states the problem in a few short words. Here is the full text of Lord Acton's comment:

    I cannot accept your canon that we are to judge Pope and King unlike other men, with a favorable presumption that they did no wrong. If there is any presumption it is the other way against holders of power, increasing as the power increases. Historic responsibility has to make up for the want of legal responsibility. Power tends to corrupt and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority: still more when you superadd the tendency or the certainty of corruption by authority. There is no worse heresy than that the office sanctifies the holder of it.

    Here is another truism - again from Lord Acton:

    The danger is not that a particular class is unfit to govern. Every class is unfit to govern. The law of liberty tends to abolish the reign of race over race, of faith over faith, of class over class.

    Here's the point - our government leaders have failed us badly. As I see it the role of government is to stand in the gap and prevent those who assume power through wealth and success in the private sector from abusing that power. The idea that political influence can be so easily bought in today's world is a testament to the times and it is as bad today as it has ever been.

    Here is a chart of the estimated average net worth of members of Congress courtesy of the Center for Responsive Politics:

    (click to enlarge)

    To put this in perspective here is an excerpt from an article on the huge disparity between members of Congress and the average American today:

    A typical American household has a net worth of about $66,740 - a value that has been declining since the start of the most recent recession. Between 2007 and 2010, the median net worth of American households sank 47.1 percent. Food stamp enrollment increased by 15.5 million since 2009 and recent job creation figures show that low-paying jobs have largely replaced higher paying ones.

    At a time when the majority is struggling financially, the nation's leaders are accumulating more wealth.

    Americans living below the poverty line rose to 49.7 million last year - a record high which equates to 16 percent of the population. A recent study also shows that the US income gap is worse today than it was in 1774.

    And this from a Daily Ticker article:

    We have this huge disparity that's only getting worse in terms of inequality in this country," says The Daily Ticker's Henry Blodget. "If it continues, the country will begin to break apart and get more and more antagonistic class warfare. It's something we have got to solve not only in Congress but in the American public at large."

    Is Congress pursuing policies that benefit middle and lower income Americans? The Washington Post found that 73 lawmakers sponsored or co-sponsored legislation that could benefit businesses or industries that involved those Congressional members or their families.

    "It's just outrageous that our legislators could be profiting directly from the legislation that they're making," says Aaron Task.

    To sum it up - as much as I love America and as much as I believe in and embrace the capitalistic ideals that made this country great - we have reached a multi-generational juncture in history where changes must be made and will be made. Our leaders have failed us and whether that is the result of human nature that puts self advancement above all else or simply a matter of making really bad decisions and policies is perhaps not relevant.

    I am in no way suggesting we assemble a vigilante lynch mob and go after our political leaders. After all, in my opinion they have succumbed to the same power induced delusions that most of us would probably fall prey to were we in their position. As Lord Acton so aptly stated:

    "The danger is not that a particular class is unfit to govern. Every class is unfit to govern."

    At the root of the problem

    Now that you know where I stand we can get on with the discussion regarding the withdrawing of monetary stimulus that threatens "global financial stability". Why would a decision by the United States to withdraw monetary stimulus by slowing down or terminating QE create global instability?

    The answer to that question is complex but we need to start with a discussion on the nature of a reserve currency. The US dollar is the world's reserve currency and providing a sufficient supply of US dollars to the world's sovereign nations is the principal function of the US as it relates to its role as supplier of reserve assets. To understand the implications one needs to understand what was decided in 1944 at the Bretton Woods Conference that resulted in what French Finance Minister Valery Giscard d'Estang termed "exorbitant privilege" - a privilege bestowed on the United States when the US dollar was established as the world's reserve currency.

    Here is the condensed version of what happened at Bretton Woods back in 1944:

    The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid-20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.

    Preparing to rebuild the main international economic system as World War II was still raging, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference, also known at the Bretton Woods Conference. The delegates deliberated during 1-22 July 1944, and signed the Agreement on its final day.

    Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (NYSE:IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. These organizations became operational in 1945 after a sufficient number of countries had ratified the agreement.

    The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.

    So the outcome of this new system was that the US dollar was designated as the world's reserve currency and the United States guaranteed that those sovereigns holding dollars would be allowed to exchange them at a rate of $35 for 1 ounce of gold. We all know how that worked out though - it didn't - and for reasons that were easily predictable by competent economists.

    The motivation for a system of trade that was fair was well articulated by Cordell Hull, United States Secretary of State from 1933-1944:

    Unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war…if we could get a freer flow of trade…freer in the sense of fewer discriminations and obstructions…so that one country would not be deadly jealous of another and the living standards of all countries might rise, thereby eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.

    We of course didn't create that system Hull hoped for - we simply transferred preferred status from Great Britain to the United States. Great Britain no longer held exboritant privilege but the United States did. And the very thing that Hull hoped for - a system based on fairness - has to this day eluded us and we now find ourselves once again at the point where something is about to happen that will dramatically change the system.

    In an article entitled - Bretton Woods and the Forgotten Concept of International Seigniorage - Dix Sandbeck expands further on the debate at Bretton Woods on the nature of the new reserve currency:

    Keynes envisaged the bancor as an international trade currency and unit of account. Its management and issue was to be in the hands of an another planned international organization, the International Clearing Union (ICU). The value of the bancor was to be determined by the value of the different national currencies in a trade weighted basket. Values of currencies would be fixed, but could be changed by mutual agreement.

    A fundamental aim of Keynes' plan was to install a truly multilateral system. No nation would be allowed to dominate; nations in surplus or in deficit would be disciplined alike. Shortly before the conference however, the Americans rescinded their support for the bancor. Presumably, they felt that the bancor scheme, with its control in the hands of the ICU, was a shrewd strategy to rob the United States of its greatest spoil of victory: unfettered post-war dominance.

    Instead, the Americans insisted on a system where the US dollar would be fixed to a gold value of $35 per ounce, though convertible only for central banks. All other currencies were to be aligned to this dollar-gold anchor. If adopted, this would confer on the US an unprecedented supremacy Even Britain, at the pinnacle of her power had not enjoyed such a position. But at Bretton Woods the exhausted European nations were eager for the continued flow of dollars to finance the war and the impending reconstruction. No nation was in a position to challenge the American volte-face.

    Seigniorage is the difference between the value of money and the cost of producing it. It is that concept that sets the US apart from every other nation in that it derives the benefit of the currencies purchase value and bears almost no effective cost at current interest rates. Here is how it works. The US government expands the debt ceiling at will and then borrows money by issuing treasuries.

    Countries who are net exporters then buy those instruments from the United States in order to invest the dollars they receive in international trade. If you are a net exporter then you build a surplus of US dollar denominated assets. If you are a net importer the inverse is true.

    The benefits to the reserve currency issuer is that they are allowed to borrow in great quantity relative to other sovereigns without the commensurate cost these other countries would incur were they to do the same. The reason is simple - if you want to import or export goods and services you do so using US dollars as the form of payment. In other words there is a high demand for dollar denominated assets for reasons unrelated to the interest rate paid on those assets.

    A country like China then ends up with a surplus of dollars and here is why. A company in China exports goods and receives in return US dollars. That exporting company then needs to convert those dollars back to the sovereign currency and so the central bank exchanges those dollars for yuans. Now the central bank has dollars which it uses to buy US debt.

    That isn't the way most investors see it though. Most investors see China as deliberately buying US debt for any number of sinister purposes. Others see us at the mercy of China and that may end up being true but not for reasons that are readily apparent.

    China by the way has a unique arrangement that links the yuan to the US dollar and that would suggest that the yuan would not appreciate if China sold US dollars and bought the yuan but that is only partially true. The problem with China is multi-faceted. A strong dollar necessarily results in a strong yuan relatively speaking due to the yuan's link to the US dollar. In other words a strong dollar could end up having a modest impact on Chinese export demand. On the other hand a weak US dollar could have an inflationary effect on the yuan domestically.

    Additionally, the Chinese use a novel approach to curbing inflation domestically. They simply raise bank reserve requirements in lieu of withdrawing liquidity. That creates an instant muting of the expansionary impact of the fractional bank multiplier. At the same time it can produce a serious liquidity crisis domestically in China when they attack inflation in this manner.

    Another problem as far as China is concerned is rooted in the US blunders from a domestic perspective that create instability in the dollar and in US Treasuries. Blunders like consistently inflating investment assets as in the mortgage debt crisis that impacted global economies across the spectrum.

    So what happens then that causes a crisis in the emerging market economies. Here is what Jim Rickards - author of Currency Wars: The Making of the Next Global Crisis - sees happening:

    If the Fed does what they say they're going to do-which I don't think they will-but if they do… and they reduce asset purchases and U.S. interest rates go up, the capital outflows are going to come from the emerging markets back to the U.S., the carry trades are going to be unwound and that's going to leave these economies high and dry," says Jim Rickards, senior managing director of Tangent Capital.

    And ultimately, those emerging markets "will have unsustainable projects and bank debt, and it could be the beginning of another emerging market crisis which as we know in 1997-1998 spread to major economies.

    Rickards made the above statement back in June. There seems to be a pretty broad consensus view today that tapering will start this year. Furthermore, projected deficit levels this year suggest that new Treasury issues will be substantially reduced in fiscal 2013 meaning that the Fed's bond buying program at current levels will consume roughly 70% of new issue.

    So even though there are a very few reasons for tapering there are perhaps a lot more reasons for not tapering. My guess is Rickards will end up being right and the US will not taper but for reasons that are again not so obvious.

    When rates start to climb the dollar carry trade loses its appeal and not just in the emerging market economies. Borrowing short term to invest long term works as long as the yield curve remains attractive. But what happens to bonds when rates start to climb. Bonds at the long end of the curve lose value and that applies to all bonds - not just emerging markets. That of course exacerbates the problem as the selling pressure on bonds begets more selling pressure.

    Is the Fed really to blame for recent bond weakness?

    The following excerpt on the matter of foreign sales of US Treasuries suggests that there is a lot more than QE taper talk driving bonds lower:

    (Reuters) - China and Japan led an exodus from U.S. Treasuries in June after the first signals the U.S. central bank was preparing to wind back its stimulus, with data showing they accounted for almost all of a record $40.8 billion of net foreign selling of Treasuries.

    The sales were part of $66.9 billion of net sales by foreigners of long-term U.S. securities in June, a fifth straight month of outflows and the largest since August 2007, U.S. Treasury Department data showed on Thursday.

    One can argue that China and Japan are selling US Treasuries as they fear the Fed is losing control of the bond market. One can also argue that they are doing so as they are no longer trading exclusively in US dollars.

    Consider this from Al-Jazeerah on the matter of trade agreements not involving the US dollar:

    Over the past two years, China has announced a string of yuan internationalization efforts that are systematically chipping away at the dollar's importance to global trade. Financial blog Zero Hedge reports: "One more domino in the dollar reserve supremacy regime falls. [T]he announcement two weeks ago that 'Australia and China Will Enable Direct Currency Convertibility' … was the culmination of two years of yuan internationalization efforts as summarized by the following":

    "World's Second- (China) and Third-Largest (Japan) Economies to Bypass Dollar, Engage in Direct Currency Trade" "China, Russia Drop Dollar in Bilateral Trade" "China and Iran to Bypass Dollar, Plan Oil Barter System" "India and Japan Sign New $15bn Currency Swap Agreement" "Iran, Russia Replace Dollar With Rial, Ruble in Trade, Fars Says" "India Joins Asian Dollar Exclusion Zone, Will Transact With Iran in Rupees" "The USD Trap Is Closing: Dollar Exclusion Zone Crosses the Pacific as Brazil Signs China Currency Swap"

    What we know is that the Fed hasn't begun the process of tapering back QE purchases yet the yield on US Treasuries has skyrocketed - doubling since the mid-2012 lows:

    (click to enlarge)

    This can only be explained in the context of foreign sales of US Treasuries. In June foreign sales of US Treasuries exceeded the Fed's purchases by roughly $27 billion. In other words US Treasuries aren't falling as a result of taper talk but as a result of the selling pressure created by those countries no longer trading in US dollars.

    If China, Japan, Australia, Brazil or one of the many other countries now by-passing the US dollar no longer receive US dollars in payment for exports then it creates an altogether different dynamic that tends to diminish the exorbitant privilege of the US.

    Take Japan as an example. If they receive US dollars in trade settlements they either hold the dollar or interest bearing treasuries. In other words they buy US Treasuries pushing bond prices up and yields down. Do they want to do that? The answer is no but they have no choice. If they simply sell US dollars and buy yens they drive the yen higher and the result is a dampening of demand for Japanese produced goods. It hurts the domestic economy so they are forced to reinforce the exorbitant privilege of the reserve currency nation.

    How are bilateral trade agreements affecting markets?

    Let's look at the bond market to see if this dynamic is really occurring. Here is the bond market (NYSEARCA:TLT):

    (click to enlarge)

    Once again we know why bonds have been weak of late - foreign sales of US Treasuries. And we know why that is occurring - bilateral trade agreements that don't result in US dollars being received to the degree they have in the past. It can be argued that the recent spike is the result of a safe haven bid for US Treasuries based on the prospects of heightened tensions in the middle east arising from the mess in Syria but will it last? Probably not as the overriding influence on bonds is the bilateral trade agreements that are bypassing the US dollar.

    Now let's look at gold. Here is (NYSEARCA:GLD):

    (click to enlarge)

    The price action of gold is not so easily explained. There are a number of issues in play. First, disinflation - not inflation - has been the predominant trend in the US of late. Here is a chart of the CPI:

    (click to enlarge)

    This tends to explain the steady downtrend in gold from October of 2012. The recent spike higher in gold is better explained by the dynamics of the various bilateral trade agreements that are bypassing the US dollar. I have argued for some time now that QE is not inflationary unless the excess reserves created by the Fed's policies result in increased M2 creation through the fractional bank multiplier as banks make loans. That hasn't occurred and therefore M2 expansion has been muted since coming out of the Great Recession.

    However, the various bilateral trade agreements that are bypassing the dollar will produce downward pressure on the US dollar even in a deflationary and deleveraging environment and this is a phenomenon few understand. It will also result in the loss of exorbitant privilege that has allowed the US to operate irresponsibly and with impunity for decades. In other words the US will no longer need to operate with high deficits in order to provide reserve assets as a condition of their currency reserve status. In truth they won't be able to operate with high deficits without consequence any longer assuming the trend to bypass the dollar gains momentum and it seems certain that will be the case.

    Is the multi decade bull market in bonds at an end? It would seem so and not specifically as a result of US fiscal and monetary policy - rather due to the US dollar losing its status as the worlds primary reserve currency. If trade isn't conducted in dollars then those countries who are large net exporters will not receive as many dollars and therefore won't have the need to buy US Treasuries with those dollars. Furthermore, the dollars they do receive will be sold in lieu of being invested in US Treasuries putting downward pressure on the US dollar.

    Debunking the capital flowing to US equities bull market argument

    The idea that capital will flow to US equities as US equities are the best value is refuted by the fact that US equities will likely suffer a major hit as China, Japan, Russia, Brazil, India and others bypass the US dollar. What will occur instead is an end to the demand for US Treasuries that has driven bond prices higher and yields lower. This can occur at a much more rapid rate than many would imagine.

    The result is an end to exorbitant privilege status for the US. Interest rates will continue to climb or normalize as some say and that will necessarily result in a deleveraging - a reduction in debt levels - that will cause M2 growth to stall out and perhaps decline. So the take away then is that even in a period of disinflation or deflation we could still see the US dollar fall relative to other currencies. It isn't supposed to work that way of course but then we don't have a period we can reference to inform us on what happens to the US dollar when it loses its reserve currency status.

    There are two arguments for the bull case. First, the economy is improving and will catch up to stocks. Second, although PE ratios are high they are still nowhere near historical highs. I won't bore readers with all the reasons why the economy isn't improving but I do want to point out the flaws in logic made by those suggesting multiple expansion allows more upside room for stocks. The chart below makes the point:

    (click to enlarge)

    The chart above shows that peak PE ratios occur at points where corporate earnings hit bottom. The chart above shows that in both market crashes in this century PE ratios spiked sharply higher and peaked at that point where corporate profits were at lows. Without overlaying the two metrics one doesn't readily get this point. Herein lies the flaw in logic by those suggesting that stocks have more room to climb based on the idea that PE ratios are substantially below historic highs. Clearly they are below historic highs but historic highs occur in a market crash as it relates to PE ratios.

    To put the matter in full perspective here is a chart of the S&P 500 for the same time frame:

    (click to enlarge)

    Concluding thoughts

    As I finish up with my comments I am listening to CNN speak of the goings on in Syria. Quite frankly I have been expecting a major sell off this week based on a shift in investor sentiment predicated in part on a risk off mindset as we ponder the matter of our involvement in another middle east action. I really expected the matter to die down a little after Obama deferred the matter to Congress. That hasn't happened though as the news coverage today has been almost exclusively on the Syrian matter.

    Despite the pundits who have argued for months that the US economy was improving or that we have more to run based on multiple expansion even if the economy isn't improving I am convinced as I have been for over a year now that we will revisit the 2009 lows in the next few months. The inconvenient truth is that we have reached a multigenerational inflection point where changes will be made on a global scale.

    Changes are happening and at a very rapid pace today. I never feel comfortable with the agendas of our leaders or the motives behind their actions and do all I can to look beneath the hood to ferret out those things others might be missing. I spend an inordinate amount of time doing just that - probably in the neighborhood of 100 hours a week. I'm not interested in re-hashing those things everyone else talks about as those things don't inform us on major inflection points in market price.

    The industry as a whole is buy side biased and very few of us feel comfortable with the idea that things will deteriorate. It is not what we want and so we experience a sort of confirmation bias looking only at those things that support what we want to see happen. I see no sense in that mindset. What I do know is that we have bull and bear markets and that neither goes on forever. When we reach price extremes and do so at points where economic metrics seem to be diverging from price we must act rationally if we hope to survive and profit during the bad times.

    Each of us has to judge for ourselves what will occur in the coming months and all I can do is inform readers of what I see and what I see is a major seminal moment that will come upon us with a suddenness that few expect. The big question is will a sell off be in the category of normal or will it be much more dramatic. I am confident that it will be the latter and wonder if maybe the time is now upon us.

    Disclosure: I am long FAZ, UVXY.

    Additional disclosure: I am also long SPY puts

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Comments (43)
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  • tampat
    , contributor
    Comments (995) | Send Message
     
    JS,

     

    You really went above and beyond with this article.
    Very informative, thanks.
    Curious what month & strike are your SPY options to expire if you care to share?.
    1 Sep 2013, 06:38 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » tampat

     

    I have Sept and Oct - strikes from 165 to 140. It is not a large play in terms of cash allocated but risk reward is worth it in my mind.

     

    JS
    1 Sep 2013, 08:13 PM Reply Like
  • bluesmoke
    , contributor
    Comments (781) | Send Message
     
    Very insightful and refreshing article. Certainly gives one much to consider. Thanks.
    1 Sep 2013, 06:44 PM Reply Like
  • Jonny Tellyarn
    , contributor
    Comments (88) | Send Message
     
    "So the take away then is that even in a period of disinflation or deflation we could still see the US dollar fall relative to other currencies."
    This implies that other currencies will experience a deflation even stronger than our own, does it not?
    I would think in such a scenario that bonds that are money good would rise in value. The only thing that could justify high yields would be expectation of default. Are you then predicting that U.S. government bonds will default?
    Thanks for an excellent article.
    1 Sep 2013, 07:52 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » Jonny

     

    US Treasuries won't default and currencies float against each other so if the dollar moves lower the euro, yen, etc would move higher in relative terms.

     

    JS
    1 Sep 2013, 08:09 PM Reply Like
  • Fear & Greed Trader
    , contributor
    Comments (4560) | Send Message
     
    Joseph,

     

    I have written that we may see the 1530-1560 level on the S & P for a variety of reasons. So your S & P 'puts" may work out for you. However it wont be because of any of the reasons that you have laid out here.

     

    if we do in fact 'pullback' to those levels it will put a good "scare" into most. as the negative rhetoric will be trumpeted everywhere. . Many will start claiming that we have seen the highs and are headed down.. Instead what it will present is another fantastic buying opportunity. I do expect we will be much higher that the 1560 level as we move into 2014.. We are in the early stages of a secular bull market as I have mentioned to you for some time now . The facts you present now will have the same impact that the previous "fears" you have presented this entire year. With all of those "Paradigm " changes that were supposed to derail the U S equity market we are down a mere 4% from all time Highs.
    Any weakness caused by "Syria" , "debt ceiling comedy act presented by the Dc crowd", "Bernanke", "tapering", et al should be used to add to quality names. This may in fact play out the same way Oct-Nov '12 played out, when you. and others warned of a market crash at the end of last year. Instead, the S & P rallied to all time highs..
    I respectfully submit that you have had it wrong since late last year and what you are presenting know will just be more of the same incorrect evaluation of the equity markets. 
    Good Luck !
    1 Sep 2013, 09:05 PM Reply Like
  • flash9
    , contributor
    Comments (3669) | Send Message
     
    Your $ argument sounds like the goldbug belief that gold goes up no matter what happens. Very long term maybe, but the last two years prove otherwise. There are so many intervening variable and the degree to which they happpen and how quickly determines the intermediate outcome whatever the final result. For instance, if the real gets weak enough, China will change its mind and want $, or Brazil will want to pay in $. By the time central banks buy gold it has been a top, ie 1980 and 2011. Maybe by the time central Banks get rid of $ as you say, it's time to buy the $. They also lose tons of money as interest rates rise. I love your writings and thorough analysis.
    2 Sep 2013, 10:31 AM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » China won't change their minds on the matter of a new reserve currency. Nor will any of the other countires moving in this direction. Russia wrote a policy paper on the matter and they stated in comments referencing the paper that the matter could actually evolve into war and that it was up to the US whether or not that happened.

     

    This isn't a business as usual matter. You won't find the matter discussed in main stream blogs or on TV for a number of reasons not the least of which is the inability of investors and analysts to even understand it.

     

    Nobody wants to pay in dollars. They are forced to as that is the way things are done and until recently no other form of payment was widely accepted. That is changing and fast.

     

    JS
    2 Sep 2013, 11:08 AM Reply Like
  • flash9
    , contributor
    Comments (3669) | Send Message
     
    Thanks for the reply. My biggest take on your article was how far along we are in the currency war. I meant there might be delays on the way to the bancor or whatever they decide to call it.
    2 Sep 2013, 08:37 PM Reply Like
  • ezkappdo
    , contributor
    Comments (20) | Send Message
     
    I read and tend to respect all the views as collectively all of the writers on SA know and understand much more than me. I do tend to enjoy Mr. Stuber's writing and those of others whose outrage of this situation, which is unique and may not be modeled well by looking at the past, we or should I say the powers that be, have gotten us into.

     

    However, with the Fed Res buying a trillion dollars a year and a reversal on future tapering in the works,(if that truly occurs), if the markets react down, and wages and household income continue to fade, and other countries continue to decrease their buying of US treasuries, and the true weakness of other nations economies becomes evident, whether Eastern or Europe happen, as soon as in Oct-Nov or later, what may happen is the worst of all fears...a profound lack of confidence in the markets. That may be what will push this or the next mild correction into something more, with the help of the algos and the large manipulators (calling for selling metals and miners yet buying them long). The Fed can affect the future until it no longer can and then all bets are off. Eventually this bull will fail and fall (sooner or later) until all parties believe we are in a state where the the upside is truly much more likely than downside, and real confidence in the next recovery will be without doubt. Now, not so much. It seems a lot (of market movers, nations, central banks, politicians) are on the fence and not one of them wants to admit they are bluffing with their weak hand. It is only buying them time, though strong brief continued upside may be on the horizon. As Kostohryz feels a 20-30% may be in the near (0-12 m) future to complete a bubble phase, I would guess that eventually market confidence will not be strong if this occurs and rather a roll over starts and confidence erodes at an accelerating rate. But what do I know? This is the gestalt of my reading too many others with strong opinions and charts to back up what they are saying.
    2 Sep 2013, 11:05 AM Reply Like
  • AwakenAmerica
    , contributor
    Comments (25) | Send Message
     
    JS,

     

    Another set of pieces masterfully placed into the puzzle! I'm glad you called on Henry Ford and Lord Acton to illustrate the absolute insanity of our government and financial leaders in pursuing policies, and non-policies, that let the middle-class languish...no, actually fall...as median net worth is at least 35% below (in 2011) 2005 highs, while that of the "average" American has increased substantially thanks to the stock market bubble. As you know, Chairman Bernanke outright lied to Congress, and to us, in July when he said his policies have not helped "Wall Street more than Main Street" Americans and that the Fed is "focused on Main Street America." Appalling!

     

    As for your change of opinion on tapering, I still believe it will start after the September meeting. Last week's hurried (and I believe contrived) first revision to 2Q GDP estimate from 1.7% to 2.5% set the stage for it; if the upcoming jobs report prints surprisingly high, I think it's even more likely. If you are correct, the jobs report will be a stinker.

     

    I'm also glad you found Jim Rickards' work to help you in continuing to connect the dots.

     

    While Keynes is derided by economic conservatives, he got it right in Bretton Woods re the sovereign reserve currency conundrum; he also said that in addition to government's need to prime the pump during economic downturns, we also should pay down government debt during periods of budgetary surplus...I suppose his disciples forgot that part of his theory.

     

    Based upon your zeal to dig in and find these urgent truths, so obvious in your excellent ongoing commentary, I believe your 100- hour-per-week claim, and I thank you for it.

     

    Doug
    2 Sep 2013, 04:00 PM Reply Like
  • ba419adv
    , contributor
    Comments (211) | Send Message
     
    JS

     

    I agree that the maldistribution of wealth in the US over the last 20 years is a major problem for the US and World economies. Not only does the US provide the World's reserve currency, it provides necessary demand for goods and services worldwide. Thus the decrease of wealth of those who would consume in the US is also a problem for all of the world's economies.

     

    Unlike capital for demand,there seems to be no shortage of investment capital worldwide. The US should sharply increase income taxes on the wealthy. This should not affect demand significantly. Payroll taxes should be made steeply progressive by reducing the rates on the wages below $75,000 and applying higher rates above $75,000 to all earned income without the current or any ceiling. This would help spur demand. Welfare should be severely limited for able bodied adults. A negative income tax could help provide incentives for the transition from public assistance to work.

     

    If these and similar reforms were enacted it would reduce US deficits and strengthen the dollar. The US government should do a "Henry Ford" for the good of the US and World's economies.
    2 Sep 2013, 04:15 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » ba

     

    Good suggestions and however we do it we sure need to do it. Nothing works better to drive economic growth than a strong and affluent middle class.

     

    JS
    2 Sep 2013, 04:50 PM Reply Like
  • Bylo-
    , contributor
    Comments (388) | Send Message
     
    Excellent, informative article once again. Thank you. I look forward to your writings. Things will get interesting when Summers takes over at the Fed.
    2 Sep 2013, 06:31 PM Reply Like
  • The_Hammer
    , contributor
    Comments (3810) | Send Message
     
    Joe thank you for a brilliant article. Yes sir you are definitely gett'en it now! You are leading the pack of this paradigm monetary shift.
    I just want to say one word to you-just one word.
    GOLD.
    2 Sep 2013, 08:55 PM Reply Like
  • The_Hammer
    , contributor
    Comments (3810) | Send Message
     
    Joe, what happens to all those trillions of dollars sloshing around the globe that are in less demand and or not needed? Hint they need to find a new home. Velocity? Gold? High Inflation?
    2 Sep 2013, 09:11 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » Hammer

     

    I agree on gold. I had originally thought we would move lower once again and perhaps take out the previous lows. Don't think so now. We are a little overbought short term and could correct but not even sure of that at the moment.

     

    JS
    2 Sep 2013, 10:21 PM Reply Like
  • Svetoslav Tassev
    , contributor
    Comments (66) | Send Message
     
    “…peak PE ratios occur at points where corporate earnings hit bottom” – Indeed, equity bulls must be careful what they wish for. However, I don’t think that the declining use of US dollars in bilateral trade agreements will be the catalyst for a US equity market crash. The loss of the dollar’s reserve status is a multi decade process. It began back in the 1990s when the EU nations began trading among each other in euros. In the mean time US equities experienced two bull markets and two bear markets. The current bull market is over! In the future the world will certainly need much less US dollars. However, linking the two is a stretch in my view.
    3 Sep 2013, 08:46 AM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » Svetoslav

     

    Agreed that the process of displacing the dollar has been an ongoing process. Today we have the euro, yen and SDR's competing with the dollar.

     

    That said since 2008 the committment to introduce a new system has been gaining steam and in the last year that has been ramped up significantly. The BRIC's are pressing this hard and other sovereigns are falling in line. The end game is to move to a non-reserve asset such as the SDR.

     

    I wonder if you are expressing an uninformed opinion or have some factual basis for your opinion. Are you famiiliar with what has taken place in this area since 2008 and in particular this year?

     

    JS
    3 Sep 2013, 06:08 PM Reply Like
  • vladkri
    , contributor
    Comments (235) | Send Message
     
    Hate to spoil the party, but for all practical purposes dollar will be the money for a very long time. Folks here forget that dollar based capital markets with all their shortcomings have unique features: size, liquidity and transparency. There are things like SEC, FRED, EIA etc. For those who are fascinated with China and Russia, any single number from China is fudged, likely a lot, and in Russia all capital markets like many other things are pure banditism. They can publish great many papers, all of them have zero value. Also, as it is abundantly clear the common currency in Europe is a spectacular failure.
    4 Sep 2013, 08:07 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » vlad

     

    What does the unreliable data out of China have to do with the selling of US Treasuries?

     

    The idea that the US dollar can retain it's status if everyone decides to abandon its use assumes a power that the US doesn't have. There is no agreement in place that dictates the reserve currency today and the US dollar retains its exorbitatant privilege by default - not by agreement.

     

    Do the math yourself. Current 10 year is puting in new highs and close to 3% now. Take it to 5% and do the math on $17 trillion in US debt - $850 billion a year just to cover the carry cost.

     

    I suppose you think that is of no consequence to a country that is already stretched to the breaking point. Those who don't understand this dynamic and assume status quo are simply wrong. There is nothing that suggests a status quo situation.

     

    What I tend to do is look for empirical support in market action and the sharp spike in gold in conjunciton with rising interest rates, disinflation and a weaker dollar can't be explained by going to the text books. It isn't supposed to work that way.

     

    I do respect your views although I don't always agree. In this instance I think you are dead wrong and offer no support for you view other than a sweeping generalization and a naive dismissal of the "great many papers" as having zero value.

     

    JS .
    5 Sep 2013, 08:32 AM Reply Like
  • vladkri
    , contributor
    Comments (235) | Send Message
     
    Agreed on debt. However, what I meant to say that tools you use for (brilliant) economic analysis available in the US are either not available or grossly misleading when applied to BRIC. It is naive to believe anything produced by Russian government or private sector. Any conclusion based on open information will almost certainly be wrong. Bunch of oligarchs sell oil and gas for dollars and turn them into real estate, guess where, in the USA and Europe. That's all that is, no policy paper matters. Now, suppose dollar drops out, then algorithm is sell oil for yuan and buy real estate in China? Really? I don't think so. Same goes for China: use cheap labor, sell stuff to USA, get dollars, move to USA (or Canada), buy real estate there. Don't worry about it.
    5 Sep 2013, 06:40 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » vlad

     

    The papers I am referring to are papers produced by economists explaining why our current non-system of global trade anchored to the US dollar is a flawed concept. It wouldn't matter though if it were another sovereign currency - the yuan, the euro or the yen for instance.

     

    Trade advantage comes from a weak currency. Economic expanison domestically comes from an expansion in M2 through the private sector multiplier. In other words a weak currency works well to expand GDP. The downside is high rates of inflation and the goal of monetary policy is to regulate the valve to keep things in balance - not to much and not to little.

     

    What we have today is a free floating system that permits no one to effectively use monetary policy to regulate economies. With the case of the US we have a conundrum in that strong demand for reserve assets creates a strong dollar in relative terms when what we want is a weak dollar from a domestic perspective. Triffin explained it and he was right.

     

    Keynes wanted a non-reserve currency that was fully independent of the domestic monetary and fiscal policy of a single nation. He proposed an agreed upon fix and the system protected those with a deficiency of reserve assets through a transfer system much like our private sector bank works when a member bank suffers a liquidity problem.

     

    The US by virtue of it's reserve currency status has been afforded a privilege no other country has - the ability to borrow and spend indiscriminately and with impunity. At each juncture where we entered recession the world bought our bonds at low rates and we were able to borrow and spend our way back to prosperity.

     

    This has worked till now - at least to some degree - just as the gold backed dollar worked until it was longer sustainable. We have ignored this situation for as long as we can and reached that point where a new system is needed to replace the non-system that currenty exists. We've learned a lot since Bretton Woods - mainly that Keynes was correct and that Rober Triffin was correct.

     

    There is no way the dollar is replaced with another sovereign currency as the predominant reserve currency but what we may end up with is a system of bilateral trade agreements and no standarized system of trade. That is where we are headed at this juncture but my thinking is that it has more to do with forcing the hand of the political class in Washington than an actual attempt to take over for the US as the primary reserve currency.

     

    JS
    5 Sep 2013, 08:38 PM Reply Like
  • glaserdx
    , contributor
    Comments (194) | Send Message
     
    Joseph-
    Fascinating and brilliant article.
    The US losing its reserve currency status seems like such a momentous event, yet it is hidden from view and takes a tireless researcher such as yourself to bring the issue to light.

     

    I wonder about the magnitude of the trade currency agreements you outlined. The impact on the bond market may be a result, but on the other hand it may not be. Perhaps these are analgous to drops of water in an ocean?

     

    Hard to grasp is that the US would seemingly want to do everything in its power to maintain its exorbitant privilege. Where is the battle being fought? Is Obama supportive of a new reserve currency (I believe you noted this previously)?

     

    Finally, it is difficult for me to grasp the changes you discuss as it would change the world as I know it.

     

    A change of this magnitude borders on fiction. This is the troubling psychological issue: one can only accept the "idea" of a new world currency only if it occurs in the realm of fiction or in some distant future. The US is too powerful, has too great a resource base, to accept your view as anything but fiction or somewhere in the far distant future.

     

    I think this is a testimonial t the power of you ideas.
    5 Sep 2013, 03:54 PM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1700) | Send Message
     
    Author’s reply » Glas

     

    We have never undertaken such a massive experiment with monetary and fiscal policy and with no perceptible economic gain at all. Since 2006 we've added more total debt than the aggregate debt accumulated from the founding of the country up to 2006. The Fed for their part has come close to quadrupling their balance sheet - a monetary policy that has inflated assets and allowed the government to finance a policy of wealth transfer of public money to the large privately owned companies who continue to exploit the arrangement with more and more layoffs while recording record profits. That is the state of things today and it can't last.

     

    An honest economist and not one beholding to the media and the status quo recognizes that we are close to the end of an era. More importantly we have no system of international trade and the floating currency arrangement currently in place prevents the effective use of fiscal policy that works to stimulate the economy.

     

    It is well beyond the scope of this comment but it is a fact and I don't use that word lightly. A floating currency system and a sovereign reserve currency simply don't allow for effective fiscal policy that stimulates domestic economies.

     

    Extract fiscal stimulus from the equation and we never came out of recession. The law of diminishing returns is in full play here. We are close to the end of an era as uncomfortable as that may be and it certainly isn't fiction.

     

    JS
    5 Sep 2013, 06:55 PM Reply Like
  • glaserdx
    , contributor
    Comments (194) | Send Message
     
    JS:
    Well said.

     

    I would hope you would write an article on the topic below. It would be fascinating and I believe your readers would be most appreciative.

     

    "A floating currency system and a sovereign reserve currency simply don't allow for effective fiscal policy that stimulates domestic economies."
    7 Sep 2013, 11:52 AM Reply Like
  • Rolytee
    , contributor
    Comments (31) | Send Message
     
    Brilliant article JS... The big question is how to prepare oneself for a situation where USD hegemony reaches a tipping point? It seems after years of debating my brother, who is an incorrigible gold bug, I may be forced to swallow some humble pie and start diversifying into precious metals in order to provide some insurance for what may or may not come!
    6 Sep 2013, 07:58 PM Reply Like
  • vladkri
    , contributor
    Comments (235) | Send Message
     
    You can't. Read Taleb's "Black Swan".
    6 Sep 2013, 09:04 PM Reply Like
  • snoopy44
    , contributor
    Comments (660) | Send Message
     
    Joseph:
    Are you suggesting that the S&P earnings are going back down to the 10-15 range while the S&P PE returns to the 70 level like in 2009?
    If so, when do you expect that to happen?

     

    S.
    8 Sep 2013, 09:29 AM Reply Like
  • The_Hammer
    , contributor
    Comments (3810) | Send Message
     
    http://seekingalpha.co...
    Joe any rebuttal
    9 Sep 2013, 07:42 AM Reply Like
  • LynRobison
    , contributor
    Comments (8) | Send Message
     
    Great article, based on facts and sound analysis. My comment is that there seems to be nothing new here. Readers of ZeroHedge and other "fringe" blogs have known and understood these concepts for a long time. If you've read Kuhn's Structure of Scientific Revolutions, you know that revolutions in science (and in other disciplines as well) do not come from the mainstream, but from open-minded thinkers who are willing to follow the data, wherever it leads them, even if it means defying conventional wisdom. Because they pursue facts, these thinkers discover important truths. But because they defy conventional wisdom, defenders of the status quo try to marginalize these thinkers by labeling them as being "on the fringe". So, isn't this article simply an example of some people from the mainstream being led to realize facts which "fringe" people have known and understood for quite some time already?
    10 Sep 2013, 11:58 AM Reply Like
  • Fear & Greed Trader
    , contributor
    Comments (4560) | Send Message
     
    Lyn,
    Your comment :

     

    "Readers of ZeroHedge and other "fringe" blogs have known and understood these concepts for a long time. "

     

    May I now add : And unfortunately have been TOTALLY incorrect on the markets.
    If that's what 'fringe' people have know for a long time please ask them to keep it to themselves,, that rhetoric is dangerous for a persons financial health.
    10 Sep 2013, 03:54 PM Reply Like
  • LynRobison
    , contributor
    Comments (8) | Send Message
     
    I think you are missing the point. If the US dollar ceases to be the world's reserve currency, why do you want to spend your time and resources playing the markets in an effort to get more dollars? Why would you want to place your wealth in a currency that will inevitably lose its value? If your mainstream sources help you play the markets just right, you might be lucky enough to net a few more dollars, but what happens to your wealth when a dollar is no longer worth a half a buck?
    10 Sep 2013, 04:22 PM Reply Like
  • Fear & Greed Trader
    , contributor
    Comments (4560) | Send Message
     
    Lyn
    With all due respect you thesis is seriously flawed along with the "fringe" element you refer to ..

     

    people seem to follow that "line of thinking' , only to watch their financial health deteriorate. Can't see signing on to that thesis now, when it's been incorrect for seemingly ages..
    10 Sep 2013, 05:34 PM Reply Like
  • LynRobison
    , contributor
    Comments (8) | Send Message
     
    That is the bottom line with mainstream thinking: a refusal to accept any indications that the status quo is not permanent. It is easy to tell ourselves that because it hasn't happened yet, it is not ever going to happen. The dollar has been king for decades, so it will be king forever. And I haven't died in 52 years, so I must be immortal. Unfortunately, a "positive attitude" and normalcy bias are not more powerful than basic arithmetic and geopolitical realities.
    10 Sep 2013, 06:08 PM Reply Like
  • Fear & Greed Trader
    , contributor
    Comments (4560) | Send Message
     
    Lyn
    basic arithmetic and geopolitical realities as you state with your thesis have returned absolutely zero to an investors bottom line. Now if you wish to believe that 'someday: the sun will not come up , so be it. in the meantime the "fringe' strategy isn't working and I suggest it has no merit..
    10 Sep 2013, 07:00 PM Reply Like
  • vladkri
    , contributor
    Comments (235) | Send Message
     
    OK, we get it. So what is it in the near future: fear or greed? Suppose I'm fine with getting a bit more rapidly obsolete dollars, Canadian ones are fine too. How can I benefit from the situation? Precondition: I refuse to buy a major market top. What gives?
    10 Sep 2013, 09:13 PM Reply Like
  • Fear & Greed Trader
    , contributor
    Comments (4560) | Send Message
     
    Vlad,
    I agree its difficult to "buy" at these levels for some , however , you should have been buying much earlier and then perhaps you wouldn't be making that statement.

     

    Having said that ,, sit back , wait for opportunities in equities as they present themselves as we are in the early stages of a secular bull market. There will be pullbacks along the way ,but the market will be much higher than where we are today ..

     

    Based on these two examples , you can decide for yourself if there is "fear" or "greed"

     

    Lets look at what transpired last month. Preliminary data from Blackrock Inc, the largest ETF provider reveals that August is poised to see the biggest cash withdrawal from all U.S. exchange-traded funds in more than three years.

     

    $16.1 billion flowed out of U.S. ETFs in August, through Thursday. Barring some massive moves Friday, the outflow this month would be the worst for the U.S. ETF industry since January 2010, when $17.1 billion came out.

     

    Bankrate's latest financial security index just reported that more than a quarter of Americans said they'd rather keep their savings in cold hard cash, even if they wouldn't need the money for more than 10 years down the road.. Astonishing ! This fact alone shows that we are not even close to any euphoria or major top in this market as some would suggest. No One believes !

     

    There is an abundance of "facts" like these.. It's simply a matter of "listening" , while you avoid the "noise" of the people who have consistently had it "wrong"
    10 Sep 2013, 09:27 PM Reply Like
  • Tack
    , contributor
    Comments (12770) | Send Message
     
    Anyone who thinks that all the boats have sailed and the world is barren of undervalued opportunities hasn't been examining issues in Europe and select emerging markets (especially, Brazil), where recoveries are just getting under way and/or share prices have descended dramatically in past months.
    10 Sep 2013, 10:00 PM Reply Like
  • eagle1003
    , contributor
    Comments (1488) | Send Message
     
    Fear and Greed: I think you will be proven correct with your predictions. The degree of complacency in the market is signalling that it's time for a good scare.
    24 Oct 2013, 04:00 PM Reply Like
  • Andrew Clifford
    , contributor
    Comments (10) | Send Message
     
    Cyptocurrency is the new paradigm for the 21st century. Central Bank fiat will go the way of typewriters and film cameras.

     

    Bitcoin, or an enhanced version of it, will become the new currency for the world, bringing an inflexible monetary base which will elminate financial booms and busts. The world economy will benefit massively from being free of all the CB distortions: money printing, bad bank rescues, interest rate manipulations, etc, which are wrecking it today.
    15 Sep 2013, 03:42 AM Reply Like
  • vladkri
    , contributor
    Comments (235) | Send Message
     
    Until someone cracks the encryption.
    15 Sep 2013, 12:11 PM Reply Like
  • eagle1003
    , contributor
    Comments (1488) | Send Message
     
    Mr. Stuber: I am now short the market by being long SPXU. I expect to see a rather nasty correction that may even look like a crash. That being said, I am now bulllish on the gold juniors and have taken on substantial long positions in gold stocks. I am also very bullish on Natural Gas and currently have several long positions in the commodity.

     

    Let's see what happens.
    24 Oct 2013, 03:55 PM Reply Like
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