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The seven stages of a dollar crisis --
... 'Experts' simplistically tout a weak dollar
as good news. No wonder many regular folks
are unaware that its dramatic decline could
spell real trouble.
By Bill Fleckenstein
Along the way to a full-blown crisis, the steps leading up to
it may either pass unnoticed or prompt insufficient concern.
That is the story of the dollar. Its decline continues to strike
many folks as good news. It is only a matter of time before
that perception changes.
The inevitable crisis will inflict damage, but those who see
where we are headed can protect themselves beforehand.
To this end, I'll explain where I believe we are in that
G7's 'lingo limbo:' How low can the dollar go?
Recently, the Group of Seven finance ministers met in Boca
Raton, Fla., to hammer out a much-parsed currencies
communiqu. Why folks take this exercise in semantics
seriously beats me. The fact is, even the seven ministers,
who are capable of speaking five languages, can't tell you
what the heck they mean. Of course, one reason they can't
tell you is that their differing agendas make it hard to
pretend that they're all on the same page.
That said, the foreign ministers probably agree on one point:
The dollar is becoming a problem, which is why the gist of
their communiqu stated that too much volatility (dollar
weakness) is not a good thing.
What we are witnessing is the unfolding of a dollar crisis.
Though its external value seems to be a nebulous concept
for many folks, as the dollar's ongoing decline builds to a
crisis, it will have a significant impact on the workings of
financial markets -- and will affect everyone's financial
well-being. (For review, please see my past columns:
quot;The dollar's dramatic decline comes out of your walletquot;;
quot;The dollar: linchpin to stocks and the economyquot;; quot;Face
up to the falling dollarquot;; quot;Fantasy, the Fed and the falling
dollar: Oh my!quot;; and quot;The dollar is on borrowed time.quot;)
Seven small steps to crisis
Here, then, is my outline of a seven-step process of creating
a full-blown crisis.
Step 1. Nobody notices or pays attention that the dollar is
Step 2. Folks wake up, but they either don't care or
rationalize dollar weakness as a good thing.
Step 3. The central banks now know they have a problem
but the bankers think the market will obey them. It will, for
a while. (This is the step we have now reached and what
emerged at the G7 meeting.)
Step 4. The dollar now tests everyone's resolve by resuming
its decline. The currency markets will not respond to
jawboning by finance ministers.
Step 5. In this step, the finance ministers are forced to take
action. (Think about it. Even if they'd stated that they wanted
the dollar to go up, nothing either explicit or implied indicates
they'll do anything about what's happening. That will come
next.) When they do take action, the market will do what they
want -- but only for a while.
Step 6. The ministers take some additional action, but it won't
be enough, and the currency markets won't do what the
Step 7. Finally, we'll have a full-blown crisis, and that will be
the end game.
Pssst, Economist: It's Al (Greenspan), not Asia
To buttress my claim that we are segueing from the initial
stages where no one cares to the next and dicier stages,
I'd like to share a few quotes from quot;Let the dollar drop,quot; the
lead editorial in last week's issue of The Economist.
Though the writer first takes a why-worry attitude toward
the decline, he seems to recognize that all this central-bank
dithering can lead to real trouble. So confusion of
conclusions notwithstanding, it's worthwhile spending a
minute on the article.
Starting with the why-worry theme, the writer argues the
nonsensical case that the dollar has, in fact, been too
strong. (If that isn't an example of drinking 'em pretty, I
don't know what is.) A weaker dollar, he says, quot;will help
to reduce America's vast current-account deficit.quot;
Well, I've got news for him. The dollar's slide of nearly
30 percent from the peak of its valuation two years ago
to where it is now hasn't done a whole heck of a lot to
reduce the imbalances. A further slide may help some,
but it's not going to do a lot either. For so much of our
manufacturing has been wiped out as we ship jobs to
Asia that we're exporting less and less of what the world
wants. Thus, it's kind of hard to fix all these problems
simply by having the dollar collapse.
Continuing, the writer points out Asia as the problem,
while missing the real issue -- incompetence and
recklessness on the part of the Fed: quot;In the short term,quot;
he says, quot;Asia might thus be seen as America's savior.
But in the longer term, Asian governments are delaying
a necessary adjustment by allowing America's deficit to
loom large for longer. This is likely to lead to an even
bigger and more dangerous build-up of American foreign
That's all true, but this is exactly the same problem that
has been precipitated by the Fed, in terms of trying to
reflate the prior bubble -- and the horrendous outcome will
be the same when this attempt at bubble-building in the
housing and stock markets again unwinds.
Vendor-financing a spending binge
He then explains why Asia has done as it's done, by
saying that it's quot;buying American Treasury bonds in order
to ensure that Americans can afford to keep spending
money on Asian goods.quot; That is, the Asians are
vendor-financing our spending binge. And he then states
the obvious: quot;This cannot go on forever,quot; and quot;sooner or
later, Asia's central banks will have to face the fact that
they are holding far too many risky, low-yielding dollars.
... Delaying the natural adjustment in the dollar and bond
yields is likely to mean that when the inevitable correction
comes, IT WILL BE MUCH MORE PAINFUL.quot; (The emphasis is mine.)
Again, this is the same point that I just raised about the
ultimate adjustments we still have not made from our
prior stock mania.
Next, the writer opines that, when the blame gets levied,
Asia will be faulted for tinkering with its currencies, but
further adds: quot;America must bear much of the blame for its
failure to do anything to curb household and government
borrowing and so boost saving. Its easy monetary and
fiscal policies are now beginning to look reckless.quot;
Well, all I can say is, now beginning? It's been that way
for a very long time.
In 'Dollar Crisis, Act II,' Bofinger follows the 'script'
To return to steps 3 and 4 of the process, I note that Peter
Bofinger, a newly appointed member of the German panel
of economic advisers, last Tuesday told Bloomberg News
that what the G7 had done showed quot;indecisionquot; about
currencies. The European Central Bank should have quot;acted
more boldlyquot; with respect to the euro. He therefore thinks
that the dollar will continue to fall against the euro. If the
dollar fell below .769, European exporters would experience
difficulties. It was at .781 euros last week, or about $1.28
per euro. The problem would arise if the euro rose above
Meanwhile, as you can see, this particular fellow is talking
about that stage of the evolution of the crisis where central
bankers must, in fact, do something. He is criticizing the
G7 for not having stated that they would do something. But,
of course, as I just pointed out, arrogant central bankers
first think it will be good enough simply to tell the market
what to do. Only after that doesn't work will they decide to
take some action. The interesting thing will be to see how
long that takes to happen.
The moral of the story is this: Ultimately, the adjustment
to our bubbles is going to come. It's going to be very painful.
And the pressure will in all likelihood be precipitated by the
foreign exchange market, though other factors could certainly
To repeat my thoughts from the beginning of this discussion,
we're in the middle stages of the process, and from here the
ride will only get hairier. Folks who understand the ongoing
process of this decline will be in the best position to protect
themselves from the ramifications as they unfold.
Bill Fleckenstein is president of Fleckenstein Capital, which
manages a hedge fund based in Seattle. He also writes a
daily quot;Market Rapquot; column on his Fleckensteincapital.com
site. His investment positions can change at any time. Under
no circumstances does the information in this column
represent a recommendation to buy, sell, or hold any
security. The views and opinions expressed in Bill
Fleckenstein's columns are his own and not necessarily
those of CNBC on MSN Money.
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