Soros Bearish on Dollar

U.S. billionaire financier, author and philanthropist George Soros believes there are lots of bubbles building in financial markets, including one in oil.

He believes better regulation is necessary to keep commodity prices at more reasonable levels.

Danielle Bochove, the business host of CBC News: Morning, recently spoke with Soros on his thoughts about the credit crisis, super bubbles, institutional investors and the Canadian dollar.

Danielle Bochove: The very first line of your book reads we are in the midst of the worst financial crisis since the 1930s. Now, since you wrote that, some people have said that the worst of the global credit crisis is over. What do you think?

George Soros: Yes, I think that the acute phase of the crisis is behind us. The authorities have learned how to provide liquidity, and so they will not allow any major institution to fail. But, unfortunately, the fallout, both for the financial system and for the economy, is yet to be felt.

DB: In fact, your book talks about the fact that we’ve moved on to new crises as well — the surge in oil prices, the global food crisis. Are these related?

GS: Yes, they are. It’s all part of the super bubble that I explain in the book but I’m hopeful, actually, the authorities are now aware of bubbles and there is a froth element in the bubble that I think can be blown off by tightening the regulations because there are position limits but they’ve been circumvented through various financial arrangements...I think that authorities are onto that and probably will deal with it before that particular aspect exaggerates the movement in commodity prices.

DB: In layman’s terms, do you believe that institutional investors should be allowed to trade the things that people really need, like food and oil, using borrowed money purely for profit?

GS: I think that this institution index buying is actually a typical textbook example of the misconceptions that come up and affect reality. It’s inappropriate and I think that they exaggerate the move. It's eerily reminiscent to what happened in 1987 when institutions bought what was called portfolio insurance. It was a craze. Everybody piled in and it created that crash. This is very, very similar and I think that the institutions themselves ought to realize and ought not to do it.

DB: If you’re wrong, and you don’t see the increased regulation you believe should happen, what happens when the super bubble collapses? What is the logical reaction to that?

GS:I mean, we are in the super bubble...so we’ve had 25 years of credit expansion, increased use of leverage. Now, you are in a phase of de-leveraging and that is actually taking place and we are in the middle of it.

DB: What does that mean? You’ve touched on this but what does that specifically mean for the global stock market over the next few years?

GS: I think the outcome is not particularly good for stocks. I’m actually bearish on the stock market.

DB: Around the world or just in the United States?

GS: I think that’s pretty global, yes.

DB: Your book also says quite frequently that we are at the end of an era. What is the impact of all of this on the United States and the U.S. dollar?

GS: Well, the dollar has weakened and it has had a twofold effect. On the one hand...it has exported the recessionary forces from the United States to the rest of the world. It actually helped the U.S. economy. It has added one per cent to the U.S. gross national product currently. On the other hand, it is importing inflation; goods cost more at Wal-Mart. I think Fed chairman Bernanke warned about that yesterday.

DB: When you refer to the end of an era, I think of something more general, and I’m wondering is this the end of an era in which the United States is the dominant economic power and the U.S. dollar is the dominant currency?

GS: Yes, I think that it’s no longer the unquestioned reserve currency. There is no real good alternative and so there has been a general flight from currencies, which has contributed to the commodities boom.

DB: So what will replace the United States and its currency as the dominant force?

GS: I think that the dollar is probably still, will emerge as the most widely used currency but the United State will have to abide by the limitations that are imposed on it by the willingness of the rest of the world to hold dollar reserves. So it constrains the ability of the Fed, for instance, to lower interest rates. That is also what was behind the Fed chairman's remarks yesterday: that if you kept lowering interest rates beyond this, the dollar would suffer further decline, so you can't go anywhere in that direction.

DB: This is a very market specific question, but how do you see Canada and the Canadian dollar faring because you obviously know a thing or two about currencies?

GS: Canada is...on the one hand, it’s a commodity-rich country and that tends to strengthen the currency. On the other hand, Canada is also very much tied to the U.S. economy. So when General Motors...shuts down a plant, one of those plants is in Ontario. So Canada is half in each camp and I think that’s more or less reflected in the way the Canadian dollar is behaving.

DB: That doesn’t answer my question though, I guess, as to your expectations for the Canadian dollar. Do you see it, for example, moving, further above parity with the U.S. dollar?

GS: You know, I cannot make these predictions because I don’t know.

DB: Earlier this week, another billionaire hedge fund manager, Boone Pickens, said that investigating possible price manipulation in the oil market is a waste of time. He said that the rise that we’re seeing in oil prices is justified by supply and demand. What’s your response to that?

GS: I think that there is a bubble in oil prices, and it has two components. There is this foundation in reality, and the interpretation and the bias in the market. Recently, this bias has expressed itself in more of a rise. So there is a froth super-imposed on the fundamental trend. Oil is increasing ... but the recent rise I think has a larger fundamental speculation and really misconception in the way the institutions have piled in on one side of the market buying these commodity indexes.

DB: This is one of the reasons that you’re bearish on the stock market and I know that at the centre of your argument is the idea that some of the most common assumptions investors make about the way the markets work are false. Where does that leave an individual investor?

GS: I think this is a very difficult environment in which to invest, and you either have to be very cautious or very nimble.

DB: Is there hope for sort of regular people? It’s become the norm now to put one’s savings into a 401k plan in the United States or in RRSPs in Canada; people put their savings into mutual funds. Are they in danger of being swamped by the big guys, the speculators? Should they even be in these markets at all in your opinion?

GS: I really don’t know what to say, frankly, because some of these accounts are well managed and others are not. There are some people who have good judgment and can manage their own account, and others need to rely on professionals. So, hopefully, people find good advisers.

DB: But do you believe that the pendulum is going to swing back and the markets will become more tightly regulated?

GS: I am not actually in favour of tight regulation, because markets are imperfect but so are regulators. And what’s worse, they’re also bureaucratic, so they are slow in responding and very bureaucratic in their response. I’m for better regulation and that is not necessarily tight regulation. I think markets have been allowed too much leeway. So there has to be better regulation, but not necessarily more.

DB: You’re also a philanthropist and I wonder how worried you are about the current food crisis and the role that speculators have perhaps played in that?

GS: I’m very worried about it. People feel it in their own pocket book. Food and energy is only a small portion of our spending, but in less developed countries it’s the bulk of what people spend money on. So they’re really desperate and you've got food riots in South Africa, Haiti, Pakistan. It’s a terrible situation.

DB: There’s a certain irony in the fact that you made your fortune as a speculator. Do you have any regrets about that now?

GS: None whatsoever because I play by the rules. And to the extent that I understand the rules are deficient, I am proposing they should be improved. That's the way I try to contribute to make the world a better place.

DB: Thank you so much with your time. It's been a pleasure speaking to you.

GS: Same here.

 

 [Via - cbc.ca]

 

How Far Has the Dollar Fallen? And Why? - What's Next?

Free $500 Southwest Airlines Gift Card

 

As you know, the dollar has been falling against the Euro for several years. But, when you hear that the dollar has fallen to historic lows versus the Euro for example, it is sometimes hard to put that in an actual historic perspective. Also, for most Americans, it’s hard to understand why the dollar is falling. With this post, the goal is to give you the best answers available on both questions — How far has the dollar fallen? And why is it falling? We also want to look ahead as well.

Let’s start with how far the dollar has fallen. One problem with our media is that the news of the day is often one-sided and it seldom comes with any historical perspective. For example, do you remember hearing that the Euro fell to historic lows versus the dollar? Well, as you will see from the chart below, it happened not too long ago. In fact, the Euro fell steadily versus the dollar for the first five years of its existence, beginning in January 1999. It did not get back to even until mid-November, 2003. At the low point for the Euro you could have bought one for 84 cents. Now, it takes a $1.56.

Here is a chart showing the fluctuations of the Euro versus the dollar since inception in 1999. This shows how many dollars it takes to buy one Euro. When the blue line is heading down, the dollar is getting stronger. When the line heads up, the dollar is getting weaker.

U.S. Dollar / Euro

Source: St. Louis Federal Reserve Bank

The gray bar in the charts indicates the relatively brief recession we experienced in 2001. You might notice that the recession coincided with the low point for the Euro (or conversely, the strongest point for the dollar during this time period). In other words, the very strong dollar and the recession went hand in hand because the Federal Reserve raised interest rates beginning in 1999 and that led to the recession. Higher rates cause the dollar to strengthen, but they also inevitably slow down the economy. On the other hand, lower interest rates are positive for the economy, but often not for the dollar.

Now, our economy has been strong for over five years and the dollar has fallen, more or less continuously during this economic upturn. Coincidence? No. Here is a chart showing the Federal Funds target rate for the same period.

Federal Funds Rate

Source: St. Louis Federal Reserve Bank

As you can see from the second chart, the Federal Reserve began raising interest rates to slow down the technology bubble in 1999. As seen on the top chart, when U.S. interest rates went up, the dollar rose versus the Euro. When the economy fell into recession in 2001 (the area in gray), the Fed began slashing interest rates and the Euro finally began strengthening versus the dollar. The Fed began raising rates again in 2004 due to inflation concerns and the Euro stabilized versus the dollar until the Fed stopped raising rates in 2006. At that point, the Euro began climbing and the process accelerated when U.S interest rates were cut in 2007 as the economy began to weaken.

What’s Next?

The big difficulty we face now is that the economy is weak and the Fed would like to cut interest rates or at least maintain them at a low level. The Fed cuts rates when it is concerned with economic weakness. As we have seen, lower interest rates helps the economy, but lower rates generally hurt the dollar versus the Euro. Due to weakness in the dollar, the response would ideally be to raise interest rates to help strengthen it. Inflation is also picking up steam and the normal response to that would be to raise short-term interest rates. Obviously, we cannot both raise and lower interest rates, so the Fed is hampered in its ability to respond to this situation.

In my opinion, this is not the fault of current Fed Chairman, Ben Bernanke, but instead the roots of this problem date back to the previous chairman, Alan Greenspan, who maintained very low interest rates for too long after the recession of 2001 and the terror attacks of 9-11.

The Fed’s current posture is that we should not expect any additional cuts to the Fed Funds rate. And, in all likelihood, we will see higher Fed Funds rates late this year or early next year as the economy begins to pick up steam. As a result, the dollar has shown a little strength lately. So the dollar should stabilize roughly around this level or a bit higher for a while and then we should see some strengthening when interest rates begin moving up (see Is the Euro Headed For a Fall?).

To put this entire discussion of the decline of the dollar in perspective, let’s look at one additional chart of the dollar versus another currency, the British pound sterling.

U.S. Dollar / British Pound

Source: St. Louis Federal Reserve Bank

This chart shows that in 1972 it took over 2.5 dollars to buy one pound. The dollar then strengthened versus the pound and this process ended in 1985 when it took only $1.10 to buy a pound. Since 1985, the pound has generally strengthened versus the dollar. That is, for the past 23 years the dollar has generally fallen versus the pound. Yet, even at the recent peak of strength for the pound — October 2007 — the pound has still not made it back to the high point it reached versus the dollar back in 1972.

In short, major currencies fluctuate against each other daily, but the overall trends cover very long periods of time. If you look at the dollar/pound comparison over a shorter period, then you see the dollar is weakening. But, if you look over the longer period shown in the chart, then you see the pound on a long-term downward trend versus the dollar.

I hope this clears up some of the confusion and also allays some of your concerns. The dollar has always fluctuated against other currencies and this is nothing new. We have some work ahead of us to deal with the contradictory implications of a sluggish economy plus resurgent inflation and a weak dollar. However, this too is nothing particularly new.

Double Digits in 1980-82: Inflation, Unemployment & Mortgage Rates

I remember the great difficulties we faced in the late 1970s and early 1980s. We had sky-high inflation, unemployment and mortgages rates. At that time, the Federal Reserve’s Chairman was Paul Volcker and he had to raise interest rates to unheard of levels. These rate hikes led to a prolonged economic contraction that was the worst since the Great Depression of the 1930s. This description from Paul Volcker’s, biography on Wikipedia gives a sense of how severe the reaction was [emphasis added]:

…However, the change in policy contributed to the significant recession the U.S. economy experienced in the early 1980s, which included the highest unemployment levels since the Great Depression, and Volcker’s Fed also elicited the strongest political attacks and most wide-spread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of the high interest rates on the construction and farming sectors, culminating in indebted farmers driving their tractors onto C Street and blockading the Eccles Building.^[4] …

Blockading farmers. It sounds almost French, doesn’t it? It’s hard to imagine that scenario now, but those were tough times.

The reason Volcker raised interest rates so aggressively was that inflation went wild in the late 1970s. For example, inflation hit 11.3% in 1979, 13.5% in 1980 and 10.3% in 1981 before Volcker’s harsh medicine began to kick in and inflation moderated to 6.2% in 1982. As inflation ratcheted higher, so did home mortgages rates.

Thirty-year fixed rate mortgages went up to nearly 13% in November 1979 and did not fall under 12% again until November 1985. The peak rate for mortgages was 18.45% in October 1981. 18.45%!

But, even though high interest rates began knocking down inflation, high rates also led to sharply higher unemployment. The unemployment rate peaked at 10.8% in December 1982. However, it had been soaring for years and it remained at 8% or higher until January of 1984.

When you hear politicians and pundits opine that this is the worst crisis since the Depression, just mentally compare current conditions to those of the late 1970s and early 1980s. We had double digit inflation, unemployment and home mortgage rates back then. Let’s see: inflation is around 4%, unemployment is 5.5% and 30-year fixed mortgages are about 6.25%. In other words, we are not remotely close to anything like double digits on any one of these factors, much less all three.

The difficulties we faced in the 1970s and 1980s were far more severe than anything we are seeing now and I am confident that the Fed and the U.S. Treasury will be able to deal with the much more moderate economic problems we are facing. We clearly have issues now, but they are not nearly as difficult as the issues we have successfully overcome in the past.

 

Free $500 Southwest Airlines Gift Card

[Via - fundmasteryblog.com]