The Dollar's Predicament
For another volatile week, the S&P500 declined 1.2% (down 4.5% y-t-d), and the Dow fell 1.0% (down 3.2% y-t-d). The Morgan Stanley Cyclicals declined 1.3% (down 2.6%), and the Transports lost 1.0% (up 0.5%). The Morgan Stanley Consumer index dipped 0.5% (down 1.7%), and the Utilities slipped 0.1% (down 4.1%). The Banks sank 4.7% (up 10.2%), while the Broker/Dealers added 0.6% (down 11.7%). The S&P 400 Mid-Caps fell 1.7% (unchanged), and the small cap Russell 2000 sank 3.0% (down 2.4%). The Nasdaq100 declined 0.6% (down 3.1%), while the Morgan Stanley High Tech index gained 0.5% (down 5.7%). The Semiconductors declined 0.6% (down 3.0%). The InteractiveWeek Internet index gained 0.8% (up 0.4%). The Biotechs declined 2.1%, reducing 2010 gains to 7.8%. With bullion down $19, the HUI gold index sank 4.0% (up 3.2%).
One-month Treasury bill rates ended the week at 14 bps and three-month bills closed at 15 bps. Two-year government yields fell 3 bps to 0.59%. Five-year T-note yields sank 17 bps to 1.67%. Ten-year yields fell 13 bps to 2.92%. Long bond yields dropped 10 bps to 3.94%. Benchmark Fannie MBS yields dropped 22 bps to 3.51%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 9 bps to 59 bps. Agency 10-yr debt spreads narrowed 2 bps to 27 bps. The implied yield on December 2010 eurodollar futures fell 5 bps to 0.58%. The 10-year dollar swap spread declined 3.25 to 2.0. The 30-year swap spread declined 2.5 to negative 22.75. Corporate bond spreads were mostly wider. An index of investment grade spreads widened 3 to 113 bps, and an index of junk bond spreads widened 8 to 688.
Investment grade issuers included JPMorgan $4.125 bn, Oracle $3.25bn, Target $1.0bn, Agilent Tech $750 million, ERP $600 million, Alta Wind Holdings $580 million, and Black Hills Corp $200 million.
Junk issuers included Cedar Fair $405 million and Windstream $400 million.
Converts issuers included Sino-Ocean Land $900 million.
International dollar debt sales included Qatari Diar $3.5bn, Petroleos Mexicanos $2.0bn, CIE Foncier $1.8bn, Sumitomo Mitsui Banking $2.0bn, Veb Finance $1.6bn, NXP Funding $1.0bn, Akbank $1.0bn, CSN Resources $1.0bn, Nova Scotia $3.25bn, Woori Bank $600 million, Jefferies $550 million, Bermuda $500 million, PTT Exploration $500 million, Banco Mercantil $300 million, Gol $300 million and Grupo Famsa $200 million.
U.K. 10-year gilt yields were unchanged at 3.33%, while German bund yields declined 3 bps to 2.60%. Greek 10-year bond yields fell 3 bps to 10.24%, while 10-year Portuguese yields rose 8 bps to 5.44%. The German DAX equities index slipped 0.4% (up 1.4% y-t-d). Japanese 10-year "JGB" yields fell 7 bps to 1.085%. The Nikkei 225 dropped 1.8% (down 10.8%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index fell 1.8% (down 9.1%), and Mexico's Bolsa dipped 0.7% (down 1.0%). Russia's RTS equities index gained 2.2% (down 3.8%). India's Sensex equities index rose 0.7% (up 2.8%). China's Shanghai Exchange fell 1.9% (down 26.0%). Brazil's benchmark dollar bond yields sank 17 bps to 4.37%, and Mexico's benchmark bond yields declined 2 bps to 4.46%.
Freddie Mac 30-year fixed mortgage rates were unchanged last week at 4.57% (down 57bps y-o-y). Fifteen-year fixed rates slipped one basis point to 4.06% (down 57bps y-o-y). One-year ARMs declined one basis point to 3.74% (down 102bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 3 bps to 5.46% (down 92bps y-o-y).
Federal Reserve Credit increased $1.3bn last week to $2.316 TN. Fed Credit was up $96.0bn y-t-d (8.0% annualized) and $304bn, or 15.1%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 7/14) jumped $13.2bn to a record $3.114 TN. "Custody holdings" have increased $158bn y-t-d (10.0% annualized), with a one-year rise of $332bn, or 11.9%.
M2 (narrow) "money" supply sank $33.9bn to $8.589 TN (week of 7/5). Narrow "money" has increased $77bn y-t-d, or 1.7% annualized. Over the past year, M2 grew 1.9%. For the week, Currency added $0.3bn, while Demand & Checkable Deposits fell $19.4bn. Savings Deposits declined $11.8bn, and Small Denominated Deposits fell $2.7bn. Retail Money Fund assets slipped $0.4bn.
Total Money Market Fund assets (from Invest Co Inst) declined $13.1bn to $2.816 TN. In the first 28 weeks of the year, money fund assets fell $477bn, with a one-year decline of $831bn, or 22.8%.
Total Commercial Paper outstanding rose $5.9bn to $1.097 TN. CP has declined $72.8bn, or 11.6% annualized, year-to-date, and was little changed from a year ago.
International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.464 TN y-o-y, or 21.0%, to a record $8.449 TN.
Global Credit Market Watch:
July 14 - Bloomberg (Esteban Duarte): "Spanish banks borrowed a record 126.3 billion euros ($161bn) from the European Central Bank in June as investors shun the debt-ridden nation's lenders. Spanish banks increased borrowing 48% from 85.6 billion euros in May... That compares with a drop of 4% to 496.6 billion euros provided to lenders by the ECB in the whole euro area."
July 13 - Bloomberg (Yalman Onaran and Simon Clark): "European banks, rattled by investor uncertainty about their ability to withstand a sovereign-debt crisis, are poised to win a reprieve in Basel, Switzerland, this week as regulators from 27 countries shape new capital rules. A push to water down stringent standards proposed last year by the Basel Committee on Banking Supervision, and to allow more time to implement them, is led by France and Germany...and lobbyists involved in the talks."
July 12 - Bloomberg (John Glover): "Government debt concerns may hinder efforts by companies and banks in Europe to refinance more than $3 trillion of bonds through 2013, Standard & Poor's said. Corporate borrowers may also be crowded out by sovereign fundraising in the region, while slowing economic growth may persuade banks to hoard cash rather than lend it on..."
July 13 - Bloomberg (Emma Ross-Thomas and Joao Lima): "Portugal had its credit rating cut two levels to A1 at Moody's... as prospects for weak economic growth after allowing its budget deficit to balloon will lead to a growing debt burden. 'The Portuguese government's financial strength will continue to weaken over the medium term,' Moody's said..."
July 12 - Bloomberg (Sarah Mulholland): "Bank of America Merrill Lynch cut its 2010 forecast for asset-backed debt sales tied to consumer lending to $120 billion from $150 billion..."
July 15 - Bloomberg (Shannon D. Harrington and John Detrixhe): "Wall Street's biggest bond dealers have been cutting their holdings of corporate debt to the lowest since September... The 18 primary U.S. government debt dealers... held $80.6 billion of corporate bonds with maturities greater than one year as of June 30, down 20% from this year's high of $101.6 billion on Jan. 20..."
Global Government Finance Bubble Watch:
July 16 - Bloomberg: "China will maintain stability in its economic policies in the second half of the year, Premier Wen Jiabao said... Wen reiterated the government's goal of balancing inflation, growth and the restructuring of the economy in a speech at the Great Hall of the People. He also reaffirmed the government's commitment to maintain a pro-active fiscal policy and moderately loose monetary policy."
July 15 - Bloomberg (Candice Zachariahs): "Goldman Sachs... said the dollar will weaken against the euro by January as U.S. growth slows, marking the bank's second reversal in two months after it forecast in June the greenback would surge to a seven-year high."
July 12 - Bloomberg (Kartik Goyal): "China's foreign-exchange reserves, the world's largest, rose by 0.29% in the second quarter, the least in 11 years, as expectations for yuan gains diminished and the European debt crisis saw capital move out of emerging markets. The nation's holdings rose by $7.2 billion to $2.454 trillion..."
The dollar index dropped 1.7% to 82.56 (up 6.0% y-t-d). For the week on the upside, the Japanese yen increased 2.4%, the Danish krone 2.3%, the Euro 2.3%, the Swedish krona 2.2%, the Norwegian krone 1.6%, the British pound 1.6%, the Swiss franc 0.7%, and the Singapore dollar 0.4%. For the week on the downside, the Canadian dollar declined 2.3%, the Brazilian real 1.5%, the Mexican peso 1.3%, the Australian dollar 1.0%, and the South Korean won 0.6%.
The CRB index increased 0.6% (down 7.5% y-t-d). The Goldman Sachs Commodities Index (GSCI) rose 0.4% (down 4.2% y-t-d). Spot Gold was down 1.5% to $1,193 (up 8.7% y-t-d). Silver fell 1.1% to $17.87 (up 6.1% y-t-d). August Crude slipped 32 cents to $75.77 (down 5% y-t-d). August Gasoline declined 1.3% (unchanged), while August Natural Gas gained 3.2% (down 19% y-t-d). September Copper dropped 3.8% (down 12% y-t-d). September Wheat surged 9.2% (up 8% y-t-d), and September Corn rose 2.9% (down 5% y-t-d).
July 15 - Bloomberg: "China's economic expansion eased to 10.3% in the second quarter and industrial production cooled more than forecast in June, signaling a deeper second- half slowdown that may add to risks for the global economy. The gain in gross domestic product was less than an 11.9% increase in January-March..."
July 14 - Bloomberg: "China's slowing expansion may encourage officials to shift policy toward sustaining the rebound in the economy forecast to account for one-third of global growth this year."
July 14 - Bloomberg: "Chinese bank lending in the first half was 28% higher than official numbers suggest as more loans were repackaged into investment products, 'distorting' credit data, Fitch... said. After adjusting for 'informal securitization,' new loans stood at about 5.9 trillion yuan ($871bn) in the first six months, topping People's Bank of China data of about 4.6 trillion yuan posted this month, Fitch said..."
July 14 - Bloomberg: "China's power consumption rose at the slowest pace since February because of weakening demand from heavy industries... Power use in the second-largest energy consuming nation increased about 14% in June... China's first-half power consumption jumped 22%..."
July 12 - Bloomberg: "China's property prices rose at a slower pace for a second month after April's record gain as the government cracked down on speculation, damping home sales in a bid to avert asset bubbles. Prices in 70 cities rose 11.4% in June from a year earlier... That compared with 12.8% in April and 12.4% in May."
July 13 - Bloomberg: "China's premier commercial-property market posted a recovery in investments and rents in the first half as economic expansion spurred demand, according to CB Richard Ellis... Purchases of high-end properties including entire office buildings and shopping malls in 15 major Chinese cities totaled almost 50 billion yuan ($7.4 billion), up fivefold from a year earlier..."
July 13 - Bloomberg (Wing-Gar Cheng): "MTR Corp., the builder of a HK$66.9 billion ($8.6 billion) high-speed train line in Hong Kong, said work on the railway may be completed ahead of schedule because of government support and commitments from contractors... Contractors will dig up 10 million cubic-meters of rock, soil and other materials while constructing the 26 kilometer (16 mile) underground railway, which will run from downtown Hong Kong to the border with China..."
July 14 - Bloomberg (Kartik Goyal): "India's inflation accelerated in June, increasing pressure on the central bank to raise interest rates for a second time this month. The benchmark wholesale-price index jumped 10.55% from a year earlier..."
July 15 - Bloomberg (Tushar Dhara): "India's food inflation accelerated for the first time in three week... An index measuring wholesale prices of farm products... rose 12.81%...from a year earlier..."
Asia Bubble Watch:
July 12 - Bloomberg (Tim Culpan): "Taiwan's central bank Governor Perng Fai-nan called on financial institutions to take steps to prevent housing speculation... 'Many people have written to show their dissatisfaction that in the past one to two months, houses have been purchased and then resold at a higher price within a short time,' Perng wrote... 'Many speculative investors have bought more than 200 houses and contracted real-estate agents to sell them, with the speculative money having come from bank loans.' ...The central bank raised its benchmark rate to 1.375% on June 24..."
July 12 - Bloomberg (Chris Cooper): "Container-shipping volumes within Asia exceeded the region's shipments to North America last year for the first time as economic growth stoked consumer spending in China and India."
July 14 - Bloomberg (Shamim Adam): "Singapore's growth accelerated to a record 18.1% pace in the first half of 2010... Gross domestic product expanded at a 26% annualized pace in the second quarter..."
July 14 - Bloomberg (Suttinee Yuvejwattana and Yumi Teso): "Thailand's central bank raised its benchmark interest rate for the first time in almost two years... The Bank of Thailand increased the... rate by a quarter of a percentage point to 1.5%..."
July 15 - Bloomberg (Ranjeetha Pakiam): "Malaysia's economic rebound is set to slow in the second half of this year after its central bank raised interest rates for a third time, the Malaysian Institute of Economic Research predicts... Southeast Asia's third-largest economy may expand 6.5% this year and 5.2% in 2011..."
July 15 - Bloomberg (Dinakar Sethuraman): "BP Plc's oil spill in the Gulf of Mexico has failed to deter the appetite for drilling in Asia Pacific, with rig use reaching an 18-year high last month."
Latin America Watch:
July 14 - Bloomberg (Neil Denslow): "China agreed to work on rail projects worth at least $12 billion in Argentina, boosting ties with South America's second-largest economy."
July 12 - Bloomberg (Drew Benson): "Argentina's economy will expand 8% in 2010, up from a previous forecast of 5.3%, Goldman Sachs Group Inc. economist Alberto Ramos said..."
Unbalanced Global Economy Watch:
July 14 - Bloomberg (Simon Kennedy): "For Germany, bailing out its neighbors to save the euro is proving a price worth paying. Rising share prices and foreign sales at Bayerische Motoren Werke AG and Siemens AG show why it may be worth keeping the single currency even as some voters balk at the cost of rescuing Greece... As exporters benefit from the lower labor costs and currency stability fostered by the euro's 1999 introduction, unemployment has dropped close to an 18-year low and the DAX Index is the 16-nation bloc's best performing major benchmark this year. That's reinforcing Germany's status as a pillar of euro stability rather than a weak link as European policy makers scramble to stop the region lurching back into recession."
July 14 - Bloomberg (Gemma Daley and Marion Rae): "Australian Treasurer Wayne Swan projected a higher-than-expected A$3.1 billion ($2.7bn) surplus in three years on surging tax revenue from mining companies as the government prepares to call an election."
U.S. Bubble Economy Watch:
July 16 - Bloomberg (Shobhana Chandra and Timothy R. Homan): "Confidence among U.S. consumers tumbled in July to the lowest level in a year, heightening the risk of a slowdown in economic growth."
July 13 - Bloomberg (Timothy R. Homan): "The trade deficit in the U.S. unexpectedly widened in May to the highest level in 18 months as a gain in imports outpaced an increase in shipments abroad. The gap expanded 4.8% to $42.3 billion... Imports and exports rose to the highest level since 2008."
July 14 - Bloomberg (Mike Dorning and Catherine Dodge): "More than 7 out of 10 Americans say the economy is mired in recession, and the country is conflicted over how to balance concerns over joblessness and the federal budget deficit, according to a Bloomberg National Poll. Just like the experts, Americans are torn about whether the federal government should focus on curbing spending or creating jobs..."
July 14 - Bloomberg (Rich Miller): "Americans harbor doubts that a financial-regulation bill about to be passed by Congress will do what President Barack Obama says it will: help avoid another crisis and make their finances safer. Almost four out of five Americans surveyed in a Bloomberg National Poll this month say they have just a little or no confidence that the measure being championed by congressional Democrats will prevent or significantly soften a future crisis.
July 16 - Bloomberg (Aaron Kuriloff): "Peter Guber and Joe Lacob bought the Golden State Warriors for $450 million, a record price for a National Basketball Association team..."
Real Estate Watch:
July 15 - Bloomberg (Dan Levy): "A record 269,962 U.S. homes were seized from delinquent owners in the second quarter as lenders set a pace to claim more than 1 million properties by the end of 2010, according to RealtyTrac Inc. Home seizures climbed 38% from a year earlier and 5% from the first quarter..."
July 14 - Associated Press (Martin Crutsinger): "The federal deficit has topped $1 trillion with three months still to go in the budget year, showing the lasting impact of the recession on the government's finances. ...through the first nine months of this budget year, the deficit totals $1 trillion. That's down 7.6% from the $1.09 trillion deficit run up during the same period a year ago... The June deficit totaled $68.4 billion, the second highest June deficit on record... June is normally a surplus month as the government collects tax payments from corporations and individuals who make quarterly payments."
July 14 - Bloomberg (Michael B. Marois): "Governor Arnold Schwarzenegger... is now tied with the lowest approval rating of any sitting governor in the state in 50 years, a public opinion poll shows."
July 14 - Financial Times (Nicole Bullock and Hal Weitzman): "The cash-strapped state of Illinois on Wedesday will set terms for a bond sale as it seeks to borrow $900m in a test of investor appetite for troubled US local issuers. States and municipalities, which raise money in the $2,800bn municipal bond market, have come into the spotlight after several years of budget deficits and worries about global public finances. 'The state of Illinois is currently the poster child for all the market concerns about the state budget deficit and inadequate public pension funding in the US,' said Triet Nguyen, a municipal bond trader at Ziegler... Illinois has nearly $5bn in unpaid bills and its pensions system is funded at about 50%, the worst ratio of the 50 states. Its inability to tackle these fiscal problems in its latest budget led to credit ratings downgrades and a rise in the cost to insure its debt against default to the highest for any US state."
July 16 - Bloomberg (Dunstan McNichol): "Illinois Governor Pat Quinn doubled to 24 the number of unpaid furlough days for 2,700 managers and staff members this fiscal year as he cuts spending to close a budget deficit of about $10 billion. The unpaid days off for non-unionized workers amount to a 9.2% cut in compensation, and will save $18 million in the state's $24.9 billion budget..."
July 13 - Bloomberg (Michael McDonald): "States can't count on the federal government for more budget bailouts, the heads of President Barack Obama's debt commission told governors. States expecting Congress to authorize more assistance are 'going to be left with a very large hole to fill,' said Erskine Bowles... States including New York and California have urged Congress to extend stimulus spending authorized to combat the recession, including extra Medicaid funding and money to pay public school teachers."
July 14 - Financial Times (Nicole Bullock and Aline van Duyn): "California usually runs local newspaper and radio advertisements when it drums up interest in a bond sale. This year, though, the cash-strapped US state has been looking farther afield for investors. At least one of its offerings has involved telephone calls and flights to potential buyers as far away as Norway and Saudi Arabia... Officials from Illinois and their underwriters, Citigroup, have also done a fair amount of globetrotting to woo investors in Europe and Asia to buy nearly $1bn of bonds... The reason for all this foreign travel is that the states are marketing a type of debt - so-called Build America Bonds, subsidised by the government to finance construction projects - and hope to attract buyers who might be looking to diversify their bond portfolios. But they are doing this at a difficult time."
July 15 - Bloomberg (Dunstan McNichol and William Selway): "There is 'less than a 50-50' chance Congress will approve the $11.6 billion in extra federal Medicaid assistance U.S. states have included in their current budgets, Pennsylvania Governor Ed Rendell said."
July 15 - Bloomberg (Justin Doom and Brendan A. McGrail): "Los Angeles Community College District... plans to sell $900 million in Build America Bonds as the yield premium that investors demand on the debt rose to a record... The so-called [Build America Bond] spread rose to 207 bps on average yesterday from about 150 three months ago..."
July 13 - Bloomberg (Dunstan McNichol): "Minnesota will delay refunds for overpayment of corporate and sales taxes for the second year running, postpone state aid to schools and medical providers and set up a $600 million bank line of credit. The measures are necessary to manage cash flow in the fiscal year that began July 1..."
July 14 - Bloomberg (Tomoko Yamazaki): "Hedge funds fell for a second month in June... The Eurekahedge Hedge Fund Index, which measures the performance of more than 2,000 funds worldwide, declined 0.5% after losing 2.6% in May..."
The Dollar's Predicament
According to the Fed's Z.1 "flow of funds" data, Rest of World (ROW) holdings of U.S. financial assets ended the eighties at about $1.9 TN and closed the nineties at $5.6 TN. By the end of 2009, ROW holdings had ballooned to $15.3 TN. During the past decade, the world's holdings of our financial assets surged to 108% of U.S. GDP from 60%.
Gigantic and unending U.S. Current Account Deficits were the major force behind the extraordinary foreign accumulation of our (largely debt) securities. This implies structural deficiencies in both the Credit system and real economy. It would also be quite unusual for such a fundamental backdrop to support a strong currency.
To better gauge the soundness of the dollar, one must attempt some necessarily subjective assessment of underlying U.S. financial and economic structures. Over the past twenty years, total system Credit rose from $12.830 TN to $52.328 TN - or from a historically very high 234% of GDP to an unprecedented 367%. The important question then becomes, "Did this unprecedented increase in debt correspond with an expansion of production/wealth-producing investment?" Does our economy have the wherewithal to pay back our foreign creditors? When will it matter in the marketplace?
In the six years 2001-2006, Total U.S. Mortgage Debt doubled to $14.53 TN. For a long time to come, the mortgage/Wall Street finance Bubble will be the poster-child for pernicious non-productive Credit expansion. And over the past seven quarters federal borrowings expanded $3.3 TN, or 49%, to almost $10.0 TN. A strong case can be made that our system's propensity for non-productive Credit creation has gone from really bad to worse.
Over the years, I have argued that our intractable trade deficits - and resulting Current Account Deficits - were the leading cause of worsening global distortions and imbalances - financial and economic. Year after year of rampant financial excess at home eventually led to the "exportation" of our Credit Bubble to the rest of the world. I have referred to the resulting Monetary Disorder associated with a "massive global pool of speculative finance" - Trillions of dollar financial flows commanded by the hedge funds, sovereign wealth funds and global speculating community. And there are, as well, the vast holdings of foreign reserves accumulated by (largely Asian) global central bankers. At $8.449 TN, international reserves have surged 20% over the past year and are up 157% in six years.
I believe the Greek debt crisis marked a critical juncture for global finance. Prior to Greece unwinding, market players perceived that policymaking ensured liquid markets and a sustainable global recovery. Global reflationary forces were supposed to underpin debt across the globe. The U.S. Credit system, economy and dollar were certainly viewed as vulnerable. But amid U.S. debt concerns, markets remained confident that years would pass before massive Treasury borrowings eventually turned problematic. Besides, U.S. vulnerability ensured ultra-aggressive fiscal and monetary stimulus. Ongoing loose finance in the U.S. and synchronized global stimulus seemed to ensure a reflationary backdrop favorable for global risk assets and economies.
All bets were immediately off after debt crisis engulfed European periphery markets; the CDS marketplace dislocated; the euro plunged; and deleveraging and contagion erupted throughout global risk markets. Almost overnight, the world viewed structural debt problems in a different - and darker - light. Yet, with the dollar and Treasurys rallying strongly, there were visions of the U.S. once again enjoying the fruits associated with a "King dollar" safe haven status. Markets don't tend to offer help to those that really need it.
With the yen trading to a one-year high against the dollar today and the Euro rallying back to 130, some reality is returning to the marketplace. It is unlikely the U.S. will provide much of a safe harbor in a world of ongoing uncertainty and financial tumult. Indeed, there are indications that the markets are beginning to discount a backdrop heavily impacted by a weaker dollar and U.S. economic fragility. And it is worth noting that the week ended with ominous declines in U.S. financial stocks.
Earlier in the week, dollar weakness supported rallies in global risk assets - equities, commodities and the emerging markets. By week's end, the focused had shifted from the perceived benefits of a weaker dollar to fears for the U.S. recovery. Equities were erratic; currencies were erratic; and commodities were erratic. Notably, those perceived with big exposure to the U.S. - from Japanese exporters to the Canadian dollar to U.S. financial and retail stocks - came under heavy selling pressure. Market concerns do appear to have turned decisively from Europe to the U.S.
Reuters today quoted China's Prime Minister Wen Jiabao: "I want to say that at this time, when some European countries are suffering sovereign debt crises, China has always held out a helping hand."
Clearly, it's a major development that Chinese deep pockets have come to the Euro-zone's aid. There are reasons for China's policymakers to see it in their best interest to purchase European debt. At the top of the list, euro weakness provided an opportunity to diversify some of its $2.45 TN - and counting - of international reserves. The markets have been focused on European structural debt issues. But perhaps the Chinese, from a longer-term strategic point of view, see European investment as more favorable than accumulating additional U.S. debt. For several years now, the Chinese have moved forcefully to diversify their holdings to include strategic investments in raw materials, commodities and other strategic assets. As for managing their hoard of currency reserves, does it make increasing sense for the Chinese to shift their emphasis to debt obligations back by more manufacturing and export-based economic structures?
Coming into 2010, market sentiment had turned negative on the Japanese yen. The talk was of Japan's enormous structural problems: intractable fiscal deficits; stagnant growth; political gridlock; and an aging population. Yet the yen is this year's star currency, closing today not far off of the strongest level versus the dollar since 1995. Despite all of Japan's problems, are the Chinese and the marketplace now willing to pay a premium for currencies from manufacturing-oriented economies? From China's perspective - and factoring in their commitment to stimulating consumer demand and imports - accumulating debt instruments that could be exchanged in the future for consumption and capital goods makes sense. The Chinese are now the undisputed banker to the world. What's in their strategic best interest?
The markets are really struggling to come to grips with the post-Greece landscape. Structural debt issues are now a key focus - though the issues and analysis are unusually fuzzy. Is yen strength and euro recovery related to the markets reassessment of the U.S. situation? Does the issue go beyond dimming near-term economic prospects? Not all debt problems are created equal. Are we in the early phase of heightened fears regarding U.S. structural debt issues? Will we see these concerns manifest first in the currencies markets? Did the dollar rally - and ongoing Treasury market strength - distract the market from the crucial unfolding issue: The U.S. Structural Debt Predicament?
Our financial system has created an unimaginable amount of non-productive debt, with our nation owing much of it to foreign creditors. Our maladjusted Bubble Economy depends on uninterrupted huge quantities of Credit creation. Today, this (non-productive) Credit expansion/inflation originates almost entirely from our government sectors. The underlying economic structure is too services-based and ill-suited to enjoy a major beneficial ramp-up in production. This may not be a new development, except that the world is increasingly focused on structural debt issues and associated fragilities.
At the same time, there is little impetus domestically or internationally to finance U.S. capital investment. Financial and economic power has shifted to Asia, and the global Credit Bubble continues to finance massive additional productive capacity throughout the region. Global imbalances - financial and economic - only worsen. Here at home, we now face a situation where our system is dependent upon ongoing confidence from both Asian central banks and the global speculating community.
To some, our recovery may look intact and stocks cheap. But our entire system is extraordinarily vulnerable to any number of potential shocks. And we'll surely face great ongoing uncertainty and market instability, as global markets struggle with how this all may play out.