-->Big Macs And A 1% Currency
The Daily Reckoning
Paris, France
Friday, 14 February 2003, Valentine's Day
--------------------
*** Enraged editor attacks CNBC commentators with duct
tape...or not...
*** J.P. Morgan shines its shoes and smartens up...and bans
Gameboys in its meeting rooms? Hmmm...
*** Wheelbarrows...Rolexes...Big Macs...and more!
--------------------
- Owning stocks is no longer investing, it's self-inflicted
terrorism. Every day, it seems, the stock market strikes
terror anew in the hearts (and wallets) of investors. Fear
holds sway in the financial markets; greed is nowhere to be
found. Fearful investors avoided stocks yesterday and
unloaded dollars. The Dow dipped 8 points to 7,750 and the
Nasdaq shed 1 point to 1,277. The greenback also came under
pressure, falling more than 1% to $1.083 per euro.
- Meanwhile, fear inspired some buying in the markets for
gold, crude oil and Treasury bonds. Gold for April delivery
recouped $4.70 of the $10.00 it lost on Wednesday, to
finish the New York Trading session at $357.70. Crude oil
prices soared well above $36 a barrel, gaining 63 cents to
$36.40 a barrel. The bond market also attracted buyers, as
the yield on the 10-year T-note dropped to 3.87% from 3.93%
on Wednesday.
- Here in New York yesterday, there was no escaping the
terrorism-induced signs of anxiety. Police were visible
everywhere; chatter about a possible terrorist attack was
incessant; and CNBC covered the topic ad nauseum - as only
CNBC can do - and even went so far as to poll its viewers,
"Have you purchased duct tape in the last week?" Here's an
idea: let's use a small part of our growing national duct
tape stockpile to seal the mouths of CNBC personalities...
- J.P. Morgan Chase is slimming down and dressing for
success..." Saddled with too much real estate in Manhattan,
J.P. Morgan Chase is cutting back," the NY Daily News
reports."The bank - which posted a $387 million loss last
quarter - now has more office space than it needs."
Therefore, Morgan is planning to sell 23 Wall Street, the
building directly across the street from your co-editor's
former office at 30 Wall.
- [An Historical Digression: Ironically, the landmark
building at 23 Wall, which once symbolized the prestigious
Morgan financial empire, was the target of New York's most
infamous terrorist attack prior to September 11th.
"On Thursday, Sept. 16, 1920," historian Daniel Gross
recounts,"a simple wagon, pulled by an old, dark bay
horse, made its way through a crowded Wall Street. At about
noon, it came to a stop about 100 feet west of the corner
of Wall and Broad streets, the section of Lower Manhattan
cobblestone that had recently emerged, in the words of the
author John Brooks, as 'the precise center, geographical as
well as metaphorical, of financial America and even of the
financial world.'
"To the south stood 23 Wall Street. Known simply as 'The
Corner', the fortress-like structure housed J.P. Morgan &
Co., the world's most powerful financial institution. To
the north stood the U.S. Assay Office [i.e. 30 Wall], where
workers were moving some $900 million in gold bars. Next to
it stood the U.S. Sub-Treasury, the building now known as
Federal Hall, fronted by its statue of George Washington.
Around the corner stood the New York Stock Exchange.
"As the bells of Trinity Church gently tolled noon, the
driver released the reins and fled. Within seconds, the
wagon delivered its lethal cargo: hundreds of pounds of
explosives. Shrapnel - bits of iron made from window sash
weights - tore through flesh, concrete, stone and glass.
Windows shattered throughout a half-mile radius, showering
glass missiles onto busy streets. Awnings 12 floors above
street level caught fire. Joseph P. Kennedy, then a young
stockbroker, was thrown to the ground by the concussive
force."
Still today, the exterior of 23 Wall Street remains
pockmarked by the effects of the blast. Morgan never
repaired the building facade.]
- Additionally, Morgan is poised to unload about two
million square feet of sublease space onto a market that is
already drowning under 10.9 million square feet of 'Class
A' sublease space.
- Meanwhile, Morgan's traders and research analysts have
been told to clean up their act...literally."J.P. Morgan
traders and research analysts, used to polo shirts and
chinos during the investment banking boom years, have been
told to get a shave and a shoe shine," the Financial Times
reports. In a three-page memo, David Hitchcock, one of the
bank's corporate mucky-mucks, upbraids the bank's equity
sales team for failing to show a"professional face at all
times".
-"It has to be said," Hitchcock writes,"that under 'dress
down', your dress code in some cases led to 'dress
collapse'. Shaving, polishing your shoes and being smart
add to the professional tone. Also, any good electrical
shop will sell you a steam iron...Try and smarten up."
- Incredibly, Hitchcock also finds it necessary to ban the
use of Gameboys in research meetings, reminding his well-
paid, well-educated charges to"take written notes".
Research analysts using Gameboys?...Hmmm...That explains
everything!
- Mr. Hitchcock also urges his staff to treat clients like
"guests". Says Hitchcock,"I want you all to behave to
these people like they are guests in your house. Treat them
as you would like to be treated yourself."
- Hitchcock's got a pretty novel idea, but it may not be
that easy to elevate the Wall Street mindset. Having grown
accustomed to treating clients like the Huns treated female
captives, trying to treat clients like"guests" might feel
a bit awkward. What's more, the"guests" might be a little
slow to warm up to Morgan's enlightened hospitality.
The Daily Reckoning PRESENTS: Since the now infamous
Bernanke speech last November, the dollar has fallen
against the major currencies and commodities, like gold.
Looking at purchasing power, interest rates and recent
history, Steve Sjuggerud suggests there's a lot more room
to fall.
BIG MACS AND A 1% CURRENCY
By Steve Sjuggerud
Federal Reserve Governor Ben Bernanke's November 21 address
has been poked, prodded, and thoroughly hashed-out here in
The Daily Reckoning. It's clear the speech was a watershed
event. A"tipping point" event, if you will.
Yet Bernanke's statement is hardly the first of its kind:
time after time, governments have shown a willingness to
destroy their currencies to pay debts. Total wipeouts have
occurred. Germany couldn't pay its war debts in 1922, so it
cranked up the printing presses to print money. By the end
of 1923, prices had risen 20-billion-fold...and the savings
of an entire nation were wiped out.
This same kind of destruction continues all over the world
today. For example, I remember taking $20 out of a cash
machine in Indonesia during the Asian crisis in 1998...and
then watching the bank machine spit out 250,000 Indonesian
Rupiah. I practically needed a wheelbarrow. During that
time, the wealth of an Indonesian fell by more than 80% in
two years as the currency fell in value. Today, an
Indonesian makes something like $200 a month.
You'd need that same wheelbarrow in Venezuela. When I was
there a decade ago, the exchange rate was about 100
Venezuelan bolivars to 1 dollar. Today, Venezuela's nutty
dictator has cranked the printing presses up...and the
exchange rate has fallen to 1,300 bolivars to the dollar.
That means, thanks to government printing of money,
Venezuelans need to make twelve times more money today than
they did a decade ago to buy one dollar.
The value of the US dollar, and hence the accumulated
wealth of those holding dollar-based assets, is now under
the same threat. I'm not suggesting wild printing like I've
described. But it's clear that Governor Bernanke is willing
to sacrifice the value of the US dollar to accomplish his
objectives.
The dollar could lose up to half its value. Said another
way, your wealth (in dollars) could be cut in half. The
thing is, most Americans won't even realize it...or even
understand that it happened.
Let's say it's March of 1985 and you've just landed in
Europe for a one-year assignment. As a banker hands you a
whopping 28,000 Swiss francs in exchange for 10,000 U.S.
dollars, you're feeling like a rich American. You travel in
luxury during your stay, and you pick up a Rolex watch for
a steal while you're there.
In March of 1988 your company sends you to Switzerland
again. You hand over your $10,000 once again...but this
time, you receive only 14,000 Swiss francs.
"You must be making a mistake," you say to the banker."No
mistake," he says."The dollar lost half its value in three
years." You're flabbergasted. You can buy only half as much
stuff this time around. And everything is twice as
expensive in dollar terms as it was on your last trip just
three years earlier.
It's not really twice as expensive. Prices of Rolexes in
Switzerland didn't go up. It just takes you twice as many
dollars to buy that same watch. From 1985 to 1988, this
really happened. The purchasing power of the dollar was
effectively cut in half. The wealth of many Americans was
crushed.
But what if you had your money in gold during that time?
Gold nearly doubled, rising from a low below $300 to nearly
$500 an ounce. In reality, gold didn't rise - what happened
was the dollar fell. It took a lot more dollars to buy one
ounce of gold. But in terms of Swiss francs, gold was
basically unchanged.
Still, 1988 was ancient history, right?
The truth is, we haven't had to care about the dollar for a
long time - seven years to be exact. In 1995, then Treasury
Secretary Robert Rubin instituted America's"Strong Dollar
Policy." And the dollar has been strengthening since.
With seven years of strengthening, the dollar is now
expensive, and has likely peaked. It wouldn't be
unrealistic to see dollar purchasing power dip
significantly again. It's already happening. A year ago a
dollar would have bought 1.7 Swiss francs. Now it's closer
to 1.4. So what's going on?
The easiest way to address this question is to take a look
at two different factors. While doing my Ph.D. work on
international currencies, I found that there are only two
clear things that affect the value of a"rich country"
currency. The first is"purchasing power" relative to other
currencies. The second is"real interest rate
differentials".
You'll hear a lot of discussion about budget deficits and
current account deficits. But they don't matter. At least
not nearly as much as purchasing power and real interest
rates.
The concept of purchasing power parity is simple. Think of
it this way...the price of a Big Mac should be roughly the
same wherever you are. The ingredients are homogenous,
cheap, and widely available. And so driving across the
border from the U.S. to Canada, you shouldn't see a huge
difference in Big Mac prices. But sometimes, you do.
In fact, right now a Big Mac is US$0.37 cheaper for
Americans in Canada than it is in the U.S. So, if you're
planning a trip to Niagara Falls, you can check out the
falls from the U.S. side. But make sure you spend all your
money on the Canadian side. You'll save a heck of a lot of
money.
Should a McDonalds in Niagara Falls Canada sell a burger
for US$0.37 less than a McDonalds in Niagara Falls New
York? Does this discrepancy in prices in rich countries
make sense? Not in the long run. In the long run,
currencies revert back to equal values - to their
purchasing power parities. Of course, that long run can be
a very long time. But they always return.
The second thing to consider is interest rate
differentials. Money flows to where it's treated best. All
things being equal, if one country is paying 5% interest,
and another is paying 1%, money will flow to the country
paying 5%. That flow will cause the value of the 5%
currency to increase as people flock to it. It's simple
supply and demand.
Based on the only two factors that I've found to influence
the value of a rich-world currency - purchasing power
parity and interest rate differentials - the U.S. dollar is
likely in trouble. Our Big Macs are expensive, and the U.S.
is a 1% currency.
Take a look at what's really happened to the dollar over
the past months. Since Bernanke's speech, the dollar has
fallen against the major currencies and commodities, like
gold. Gold is now at 6-year highs versus the dollar.
The logic is simple...no matter what happens right now,
gold should rise. If the Fed prints money, that creates
"money" inflation - which means there will be more dollars
in the world, but the same amount of other stuff, like
gold. This drives the price of gold higher.
On the flip side, if we fall into deflation, gold will do
well also. For many reasons, the folks at the Fed are
seriously afraid of deflation. So if we dip into a period
of falling prices, expect the Fed to print money to offset
it. The expectation of the Fed's actions alone will be
enough to drive the price of gold higher.
Regards,
Steve Sjuggerud
for the Daily Reckoning
|