US Dollar suffers as perhaps the $700 billion is not enough.

Foreign Exchange Currency Outlook : Some foreign exchange traders are fearful the Paulson plan will get watered down or otherwise hijacked by a Congress more concerned about the voter (in election season) than about the banks. We say it would be smarter to fear that it will not be modified and even watered down. Bubbles always proceed the same way. They start with excess money supply, according to Kindleberger, balloon out on fantasies, hopes and scams, and burst on nothing much as all, just their own excess. The human mind somehow collectively comes to know when too much really is too much. For the government to try to prevent the bursting with more hot air, so to speak, is to try to turn back the tide or change the course of a mighty river. It can be done and has been done, but it’s cheaper and healthier to let the process roll out naturally. People who do not get punished for crimes commit them again when the act is well-rewarded.

Bankers are recidivists just like hold-up artists.

Or perhaps the $700 billion is not enough.

Market News cites research by Merrill Lynch indicating it’s about 10% of the potentially troubled assets. “To put the size of TARP in perspective, outstanding residential mortgage backed securities (RMBS either securitized or whole loan) total about $5.8 trillion. Outstanding commercial mortgage backed securities (CMBS securitized or whole loan) total about $3.4 billion. Merrill Lynch mortgage strategists say at distressed prices $700 billion equates to more than $1 trillion at face value and so the TARP program could acquire 10% of the outstanding market RMBS and CMBS market.”

It goes without saying that nobody has the slightest idea whether 10% is enough.

But clearly some initiative is going to be taken and however bad or good it turns out to be, vigorous and speedy action should be rewarded. While a banking crisis is always bad for a country and its economy, it’s not always bad for a currency. Again, the only model we have is Japan in the 1990’s after the real estate and stock market bubble burst in 1989. It took nearly two decades for the banking sector to get back on its feet, but the yen was not always affected by the crisis. In fact, the market often simply ignored the banking crisis and we recall writing many a morning briefing marveling that the yen was rising to ridiculous levels considering the deflationary effect of the crisis. Japan came close to a 1930’s era Depression, the only other time in modern history. From this we got the Keynes’ phrase “pushing on string” as one initiative after another failed, including stimulus checks. But the US dollar to Japanese yen moved sometimes independently of the crisis. It rose from 101.41 at end-1999 to 134.80 in Feb ’02, but the Japanese yen strengthened to 102.34 by end 2004.

This is a point made also by Morgan Stanley economist Stephen Jen. The crisis doesn’t necessarily tell us anything about the dollar. But Japan was not the issuer of the primary reserve currency and not the main military superpower, nor the leading world economy. Technically the Japanese economy is still the world’s second largest and certainly one of the most innovative, but not the “leading” economy. If Japan sneezes, the rest of the world doesn’t catch a cold. This is demonstrably not true for the US role.

When the US sneezes, stock markets around the world go down.

Then there is the argument that “it’s worse for the other guy.” It’s not nice to say so, but the dollar can be rescued by a bad Event or worse conditions someplace else. In this instance, it’s Europe. Signs of recession are appearing, along with signs that unions will be firm in their demands, although we are always impressed by European union statements and they almost always fold in the end. The word for this is stagflation, and Europe has less ability to get out of it than the US because of the famous labor market inflexibility. So let’s say Europe gets recession but the US squeaks by without recession.

Isn’t that US dollar favorable?

We say the answer lies not in the economics but in two other places—the election and the chart. Starting with the chart-prices never move in a straight line. We must expect pullbacks. In fact, by Friday, if the Paulson plan is looking better and if Congress gets adjustments that seem sensible to the public, the US dollar futures could rally. We would not sell US dollars into the weekend as things look today. Having said that, we have to expect a “sell on the bounce” mentality. The US and the US dollar are unpopular today. Economic comparisons are not at the top of anyone’s list. Growth doesn’t count when a system is being screwed up by its managers.

The other factor is the election. Let’s say the Paulson deal gets done and we don’t like it. McCain, if elected, would let the foxes keep control of the henhouse. It’s the Republican Party thing to do. It’s what his advisors and campaign contributors would want him to do. We saw how that worked out with the Bush-Cheney administration and the oil industry (specifically, Enron). But if Obama gets the job, he would not be shy about going back and un-doing what Paulson is doing today.

This is only one of the reasons we think that a McCain administration is bad for the US Dollar and an Obama one is good for it, whatever our old-fashioned ideas about Dems being tax-and-spend and the GOP being the party of business. Clinton should have put an end to those old prejudices—he is the one who balanced the budget, after all—but somehow they linger. The world likes it when the US takes the initiative. We need to fear that the Dems might be protectionist and impose trade barriers, and other things like that—but on the whole, when you’ve got a mess caused by rich fat-cats, bring in the Dem janitors. They can’t make it worse—can they? This is not a poltiical prefernce. We think Obama is an empty suit and McCain may be trigger-happy, and we don’t like either one of them. But as a commentary on the mood in the US today and the rest of the world—they don’t vote but they do invest

Obama has the edge in the dollar’s favor.

Bye For Now

Barbara Rockefeller

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