[IP] Boneheads, Iraq and the Artificial Dollar - John Mauldin'sWeekly E-Letter

[Dave Farber <dave@farber.net>]

------ Forwarded Message
From: "Faulhaber, Gerald" <faulhabe@wharton.upenn.edu>
Date: Sat, 29 Mar 2003 13:20:16 -0500
To: Dave Farber <dave@farber.net>
Subject: RE: Boneheads, Iraq and the Artificial Dollar - John
Mauldin'sWeekly E-Letter

I'm glad somebody was willing to invest lots of time and effort debunking
this oil-currency myth.  Glad to have one journalist who actually appears to
know something debunk another, who actually appears to know nothing, so
completely and thoroughly.  Nice work, John Mauldin.

-----Original Message-----
From: Dave Farber [mailto:dave@farber.net]
Sent: Saturday, March 29, 2003 12:42 PM
To: Faulhaber, Gerald
Subject: FW: Boneheads, Iraq and the Artificial Dollar - John
Mauldin'sWeekly E-Letter



------ Forwarded Message
From: Gordon Cook <cook@cookreport.com>
Date: Sat, 29 Mar 2003 12:33:07 -0500
To: dave@farber.net
Subject: Fwd: Boneheads, Iraq and the Artificial Dollar - John Mauldin's
Weekly E-Letter

This is a much more detailed analysis of why the  Geoffrey Heard
letter is a crock





>To: cook@cookreport.com
>Date: Sat, 29 Mar 2003 08:13:17 -0600
>Reply-To: <johnmauldin@investorsinsight.com>
>Sender: <johnmauldin@investorsinsight.com>
>From: "John Mauldin and InvestorsInsight"<johnmauldin@investorsinsight.com>
>Subject: Boneheads, Iraq and the Artificial Dollar - John Mauldin's
>Weekly E-Letter
>X-Mailnum: 1056258
>MIME-Version: 1.0
>Status: U
>
>
>  Thoughts From The Frontline
>John Mauldin's Weekly E-Letter
>Boneheads, Iraq and the Artificial Dollar
>by John Mauldin
>March 28, 2003
>
>On Boneheads, Iraq and the Artificial Dollar
>Central Banks Wave the White Flag
>As the Dollar Churns
>The Artificial Dollar
>The Competitive Currency Dance
>A Quick Look at the Economy
>
>The past two weeks I have had so many people email me an article by
>one Geoffrey Heard of Melbourne, Australia that I am going to
>comment on his nonsense. Because it is so wrong and yet his
>arguments seem so seductive, it offers an excellent opportunity for
>us to learn how world currency transactions really affect the price
>of gold and oil and other commodities. Warning: I am taking off my
>gloves in this letter. This is one of the more boneheaded pieces of
>conspiratorial economic garbage that I have read in quite some time.
>I normally don't respond to such ranting, but because it is
>seemingly being read and repeated in a lot of places, it deserves
>some attention.
>
>Basically, his thesis is that the United States (and Bush) is
>invading Iraq to insure that they will still stop selling their oil
>for euros. Bush and the American elitists he represents are
>apparently afraid that all of OPEC will want to convert to euros. To
>quote:
>
>"In 1999, Iraq, with the world's second-largest oil reserves,
>switched to trading its oil in euros....Iran started thinking about
>switching too; Venezuela... Russia...The greenback's grip on oil
>trading, and consequently on world trade in general, was under
>serious threat. If America did not stamp on this immediately, this
>economic brushfire could rapidly be fanned into a wildfire capable
>of consuming the U.S.'s economy and its dominance of world trade."
>
>"It is the biggest grab for world power in modern times.... If
>America invades Iraq and takes over, it will hurl the EU and its
>euro back into the sea and make America's position as the dominant
>economic power in the world all but impregnable.... This debate is
>not about whether America would suffer from losing the US dollar
>monopoly on oil trading-that is a given-rather it is about exactly
>how hard the USA would be hit. The smart money seems to be saying
>the impact would be in the range from severe to catastrophic. The
>USA could collapse economically.... The key to it all is the fiat
>currency for trading oil... Under an OPEC agreement, all oil has
>been traded in US dollars since 1971 (after the dropping of the gold
>standard) which makes the US dollar the de facto major international
>trading currency. If other nations have to hoard dollars to buy oil,
>then they want to use that hoard for other trading too. This fact
>gives America a huge trading advantage and helps make it the
>dominant economy in the world."
>
>Heard goes on to write about other US offenses, making clear that he
>understands the reasons for the vast conspiracy in which Bush and
>company are engaged. He clearly does not like the current US policy
>and looks to blame any and all world problems on Bush. Conspiracy
>Theorists of the World, Unite!
>
>First, let's look at his first thesis: if OPEC began to sell oil for
>euros, it would doom the dollar and be a catastrophe for the US:
>"The USA could collapse economically."
>
>You could make a case that in 1971 the oil for dollars deal was good
>for the US, but it was not some conspiracy or "deal." At the time,
>there was no other major currency with enough scope and supply to
>function as a major trading currency. The euro did not exist. The
>German mark and British pound did not simply have the supply of
>currency necessary without stretching the currency markets.
>
>That was a period in which central banks had some measure of short
>and medium term control over the valuation of their currencies. By
>working together, they could establish a price range between
>currencies.
>
>Then came 1992. The foreign currency markets had grown dramatically,
>and central banks were struggling to control their currencies.
>George Soros and the legions of traders who were investing/betting
>in the currency markets decided the pound, among other currencies,
>was over-valued, and were shorting the British pound.
>
>Legend has it that a reporter came to him and asked him what he was
>going to do because the Bank of England was going to spend $30
>billion pounds defending the value of the British pound. Supposedly
>his answer was, "What are they going to do in the 30 minutes after
>that?" $30 billion pounds was about 30 minutes of trading on the
>currency exchanges at that time.
>
>The point was that central banks no longer had enough money to
>support a currency. To support a currency you have to have foreign
>deposits in order to buy your own currency. While the bank of
>England could print all the pounds they wanted to, they could not
>manufacture dollars or marks or yen. Those currencies had to come
>from actual trade surpluses, which England did not have at the time.
>
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>
>
>Central Banks Wave the White Flag
>
>Within a few weeks, what I regard as one of the more remarkable and
>important op-ed pieces of the last half century appeared in the Wall
>Street Journal. It was an article by Walter Wriston, chairman of
>CiticCorp and the ultimate insider: Council on Foreign Relations,
>Tri-Lateral Commission and confidant of presidents and world leaders.
>
>In it, he basically waved the white flag. We were in a brave new
>world where currencies were no longer controlled by central bankers
>but by currency traders. I remember reading it and recognizing the
>truth which it contained. I, for one, was happy.
>
>In essence, the ability of central banks to manipulate their
>currencies for more than a short time was gone. Even acting in
>concert, central banks do not have the real ability to affect the
>markets for more than a few days. The most they can do is threaten,
>which keeps short term traders nervous, but currency trades back up
>like flood waters at a dam, eventually pouring over.
>
>Today, Chuck Butler, currency trader at Everbank tells me the world
>currency markets trade $1.2 trillion a day. That is almost one half
>a quadrillion dollars a year. To provide some perspective, the
>entire US economy is "only" $12 trillion or so.
>
>The total value of oil trades a day is a drop in the bucket compared
>to the currency markets. If OPEC wanted to be in euros all they have
>to do is convert to euros. You could price oil in terms of any
>currency, but those who sell must do something with the dollars or
>yen or yuan or pesos they get. After the money is in an OPEC bank
>account, they can do anything they want with it.
>
>If OPEC decided they wanted to price oil in euros, it would make no
>difference to the US price in dollars. It is supply and demand, and
>currencies are extremely liquid.
>
>Heard writes "If other nations have to hoard dollars to buy oil,
>then they want to use that hoard for other trading too." In light of
>the liquidity in the currency markets, this is a stupid statement.
>You could "hoard" any major currency (yen, pesos, euros, pounds,
>won, renminbi, etc.) and when you want to convert it into dollars to
>buy oil you can do so instantly and with almost no transaction cost.
>A country or business will keep its reserves in whatever currency it
>thinks is the best at the time and then convert for the sale. There
>is no "hoarding" of dollars, unless that is the currency the various
>central banks or businesses want to use.
>
>As an example, let's look at gold. Gold is in a great bull market,
>right? On July 1, 2001 gold was 265, and today it is around $330.
>That is a $65 rise for about a 25% gain.
>
>On that same day, the euro was $.8378 and today the euro is $1.07.
>The euro has risen almost 30%. Which is the bigger bull market?
>
>Furthermore, if you live in Europe, there has been no gold bull
>market since July, 2001. Gold, in terms of euros, is actually down
>slightly, depending on what day you look at gold and currency
>prices. On July 1, 2001 you got 316 euros when you sold an ounce of
>gold. Today you only get 299 (at $1.07).
>
>The same applies to oil. In the US, we have watched as oil prices go
>through the roof. Depending on what period you use, oil is up only
>slightly in Europe. Is that because OPEC loves the French? Of course
>not. It is entirely because the dollar has dropped against the euro.
>
>If oil were priced in euros, the results would not be any different.
>The price would have risen in the US and been almost flat in Europe.
>The reasons for the drop in the dollar have nothing to do with Iraq
>or oil. We will discuss the real reasons a bit later.
>
>Look at it this way: there is x amount of oil available for sale on
>any given day. It will go to the highest bidder. If someone from
>Europe wants to buy oil, in reality he is paying in euros. The
>conversion to dollars is transparent to him. In large amounts, it
>costs almost nothing to convert to dollars or pounds or any
>currency. Oil is no different than wheat or sugar or any other
>commodity. It is supply and demand that determines the price, and
>the currency used for the transaction has nothing to do with it, as
>long as it is liquid.
>
>To claim, as Geoffrey Heard does, that the dollar would drop because
>of oil being priced in euros is absurd and shows a complete lack of
>understanding of how the currency markets work.
>
>Further, to suggest that "If America invades Iraq and takes over, it
>will hurl the EU and its euro back into the sea" is equally absurd.
>What if America decided to invade Australia to take over its wheat
>crop? Would that hurl Canada and its dollar into the sea?
>
>Heard's thesis is based upon the presumption that the US wants to
>maintain a strong dollar, when in fact the clear leaning, if not
>actual private preference, at both the Treasury Department and the
>Federal Reserve is to allow the dollar to drop. While the Bush
>administration gives lip service to a strong dollar, they have also
>made it clear that they do not intend to intervene to support it.
>"Let the market work" is the mantra. A falling dollar helps the Fed
>control deflation.
>
>A gradually falling dollar works to our benefit by making our
>products cheaper on the world markets. It allows US producers to
>compete with foreign companies for the American consumer dollar. It
>helps stem the deflationary tide. And it helps lower the trade
>deficit, as it makes imports more costly and helps our exports.
>
>Further, Heard's thesis assumes the US is capable of controlling the
>value of a dollar. It is not. The world currency markets are far
>bigger than the US Federal Reserve. The only unilateral power a
>central bank has is the ability to destroy its currency by printing
>too much of it.
>
>Oh, I suppose the Federal Reserve could reduce the money supply and
>the supply of dollars and drive the dollar up. But classic economic
>theory says you can control the quantity of a product (in this case
>the dollar) or the price, but not both. Reducing the money supply
>would currently throw the US into a severe deflationary recession
>and possibly lead to a world-wide depression. That is not a policy
>that is likely to be pursued.
>
>As the Dollar Churns
>
>With that as background, let's look for a moment at some of the
>seismic changes which are happening in the world currency markets. I
>am going to suggest to you that one event leads to another which
>leads to another and the result is not what you are hearing in the
>mainstream press.
>
>The first thing to notice is the huge US trade deficit, currently in
>excess of $500 billion. This is now close to 5% of GDP, and as noted
>this time last year, in every case in history when a country reaches
>a trade deficit of 5%, a serious currency correction follows.
>
>As long time readers know, a 20-30% drop in the currency does not
>bother me. The US went through such in the 1980's, and life seemed
>to go on just fine, thank you.
>
>The Artificial Dollar
>
>The dollar is artificially high. By artificial, I mean the following
>things: first, the rest of the world, and especially Asia, is hooked
>on selling products to the American consumer. If prices were to rise
>30%, we would buy less of their products and more of our own. If
>they sell less, their unemployment rises and profits drop.
>
>For now, they are willing to take dollars because it keeps their
>factories going. They convert those dollars into local currency or
>other currencies.
>
>Secondly, there are those who hold dollars because it is better than
>their local currency. Physical dollars are desired in many Latin
>American and African countries, and other parts of the developing
>world. The clear pattern is that the dollar is a better value than
>the local currencies.
>
>Could the euro become as popular a currency? Sure, but then there
>would be two choices, not an abandonment of the dollar. Will it be
>more popular than the dollar? In some countries, yes, especially
>those closer to the Eurozone. But the primary driver for such
>holdings is not to get the best performing currency, the euro or the
>dollar, but to have a currency which is not their local currency,
>which their local governments continually inflate and debase.
>
>Third, it is obvious that if we were not the reserve currency of the
>world, the dollar would not be as high. The dollar would have less
>buying power. Foreigners look at that buying power and are often
>jealous, seeing it is part of American hegemony.
>
>But it cuts both ways. An artificially strong dollar has meant that
>our manufacturing base has slowly been eroding as more and more jobs
>leave the US for cheaper production climates. There is no free lunch.
>
>As I noted one year ago, Morgan Stanley projected that a 20% drop in
>the dollar against the euro would knock 1% off of the GDP of Europe,
>and it looks like it is doing just that, as it hurts their sales to
>us and makes their goods and services more expensive to the rest of
>the world. If the dollar were to drop another 10% or go to $1.25 you
>will hear screams and moans throughout Europe, as business would
>have to compete against much cheaper production from not only Asia
>but from the US.
>
>A rise to US$1.25 euro means the price of products made in Europe
>would have risen 50% in terms of dollars over a period of just a few
>years. This will give the US and Asia a huge advantage in selling
>products and services to Europe and a major competitive advantage in
>the rest of the world. If European businesses are already having
>problems (and the statistics suggest they are) then this would be
>even more devastating.
>
>What could Europe do? They could ask for an increase in tariffs, but
>this would start a trade war which they would lose, and could
>possibly trigger a world-wide recession. It would also contravene a
>lot of treaties they have worked very hard to get signed, and also
>cause a major split within the European Union. This is not a likely
>scenario.
>
>The more likely effort will be to get the Chinese to allow their
>currency to float against the dollar. Today it is pegged to the
>dollar, which means a fixed amount of Chinese currency always equal
>a dollar. If the "peg" is taken off, the Chinese currency will rise,
>thus making their products more expensive and European (and US)
>products relatively more competitive.
>
>The rest of the Asian Tiger countries will be able to let their
>currencies rise along with the Chinese renminbi. None of these
>countries are against a stronger currency as long as they to do not
>lose competitive advantage against each other.
>
>Foreign products will cost US consumers more, we will buy less and
>will be able to sell more of our products and the trade deficit goes
>down. (This whole process could take a decade or longer.)
>
>
>John Mauldin
><mailto:johnmauldin@investorsinsight.com>JohnMauldin@InvestorsInsight.com
>
>Copyright 2003 John Mauldin. All Rights Reserved.
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