Hardly any of us know how an automobile actually provides locomotion. Sure, we understand fuel goes in it somewhere, combustion provides the required power, forcing the vehicle forward as efficiently as possible on its circle-shaped tires. That’s all we really have, the very basics, a vague notion of a system whose full and complete details aren’t necessary to any one of us starting the thing up and driving away at high speeds.
But when it sputters and encounters less than ideal performance, we’re at a total loss. And at the mercy of those who have attained the knowledge therefore ability to first diagnose before then – hopefully – fixing every issue.
What if there were no mechanics?
In a letter to his son John, Axel Gustafsson Oxenstierna af Södermöre, one of the first great political reformers of the Enlightenment, encouraged his offspring to have no fear speaking up on important issues even in the most esteemed of crowds. The father wrote, in Latin, “An nescis, mi fili, quantilla prudentia mundus regatur?”
“Do you not know, my son, with how very little wisdom the world is governed?”
True in the (previous) Dark Ages, but surely not in the 21st century world brought up in the warm afterglow of the Scientific Revolution. We’re all so information-saturated, brimming with education in the finest modern traditions.
Then the car won’t start.
Oxenstierna’s point was more than a warning about straying too far from practical knowledge. After all, he stood witness to what for centuries had been taken as given – or given by God - for “what we all knew” instead being torn down and overthrown one ideal and ideology after another. It only took time.
It’s not just that those who don’t have answers must end up in the dustbin of history. Where advancement really comes from is figuring out the right questions to ask.
For decades, practically no one has been asking any from Economists. They’ve been busy enough if only within their own realm of statistical modeling. Among their most well-known a fellow by the name of Paul Krugman who today is oftentimes little more than a political pundit.
Occasionally, however, he detours back to his former profession if only to enlighten us with how little useful wisdom gets passed around within its unrighteous corridors. This week, Dr. Krugman, the Nobel Laureate, confessed he can’t reckon the US dollar. It’s become sensational, he writes, which is incompatible if not categorically incongruent with how the currency has been understood for ages.
“The aura around the power of the dollar revolves around why it remains dominant even though the US economy isn’t. The more puzzling aspect is why fluctuations in the dollar have such strong global effects.”
He’s correct. The dollar’s influence has almost nothing to do with the US economy (in isolation), but there is no mystery here.
A small step forward, hooray, Krugman has finally realized that when the dollar goes up it spells trouble for everyone. From India into China now Hungary and even that ancient (by American standards) domain of Sweden, the exchange value isn’t the problem, rather what the exchange value truly represents.
This is the “thing” Economists cannot make make sense, the great mystery to the entire establishment. Having gone through these rising dollar episodes repeatedly since around March 2008, more than enough to be put into notice.
Recall how this is one hundred eighty degrees opposite from how it was said more than a decade ago. In late 2010, the rest of the world was up in arms over the dollar’s imminent crash. The bastard “money printers” at the Fed were unleashing a “currency war”, as Brazil’s Finance Minister, the hapless Guido Mantega, had once claimed just after Ben Bernanke unofficially confirmed QE2.
Nowadays, after all this time of only going the other way, the EM cohort of officialdom complains wildly about the dollar having already gone way too high and their own currencies suffering the lows for it! Revealing thickness in such irony.
Referencing (again) India, the RBI’s recent characterization should be well more than enough to start putting two together with two: “EMEs are facing a rapid tightening of external financial conditions, capital outflows, currency depreciations and reserve losses simultaneously.”
The last on Shaktikanta Das’ list, reserve losses, involves the too-often heavy selling of reserve assets, which just so happen to be US Treasury securities. Dollar-denominated, obviously, they’re prized for their liquidity characteristics even if hated for their plainly disgusting credit qualities.
At FRBNY, a couple staffers last week asked, how can safe asset markets be fragile? Their concern, arising out of March 2020 experience, is that the Treasury market can experience great stress and strain when it wasn’t supposed to be vulnerable.
Heavy mostly foreign selling (a ha!) contributed to dislocations up and down the marketplace, essentially bifurcating issues, separating securities by their liquidity characteristics (on-the-run vs. off-the-run).
“This was highly unusual, as Treasury prices typically increase during times of stress. Using a theoretical model, we show that markets for safe assets can be fragile due to strategic interactions among investors who hold Treasury securities for their liquidity characteristics.”
What follows is the typical, useless mainstream study picking apart all the effects coming after, forcing inquiry to a muddle of inconclusive conclusions. Never once do the researchers ask the right question: why was UST selling so heavy in the first place?
The problem isn’t the UST market or how it operates, rather why the UST market had come under pressure to begin with. What makes this particularly frustrating is that the answer is right there, even when first written from Hindi, Chinese, or Swedish.
Let’s work backward starting from FRBNY: Treasury market dislocation because of heavy especially foreign sales. We know from India (and China) those sales are when whichever country experiencing reserve losses; and, reserve losses, or “outflows”, are in tandem with currency depreciation where the “currency war” shoe is suddenly on the other foot.
Rather than damning the Fed for destroying the dollar, EME officials are faced with their own importantly involuntary currency devaluations. The other side of those is, by definition, this damned rising dollar.
This is right where the textbook says you blame the Fed, which is, understandably, what reserve managers around the world are (diplomatically) doing. Yet, even Paul Krugman realizes this isn’t a question.
“But why is the dollar up so much? At first sight, the answer seems obvious: It’s all about the Fed. The Federal Reserve has been raising interest rates to bring inflation down, which, other things being equal, makes buying dollar assets more attractive and raises the dollar’s value. But the Fed isn’t the only central bank hiking rates. International economists normally believe that exchange rates are driven by long-term, not short-term, rates — and long-term rates depend not just on what a central bank has already done but on what investors expect it to do in the future.”
For having swiftly eliminated the Fed from the list of suspects we should all give Paul full marks. But here he stalls; dismissing rate hikes, he walks through one recent study’s wholly underwhelming, nonsensical claims (the reason for his article) about “a rising dollar creates balance sheet problems around the globe.” Finding this unconvincing (for obvious reasons), yet Krugman can go no further toward the light.
He's left with a major puzzle which to him and those in his class is unsolvable; basking in the growing chaos of what sure looks to be a worldwide deflationary debacle, he meekly offers no more than observations of the effect. “Whatever the reasons, however, it’s clear that the strong dollar is inflicting a lot of pain on economies around the world.”
Can a major supposedly scientific discipline truly be this unenlightened about something so basic yet so fundamental to the nature of our modern world?
An nescis, amicus meus, quantilla prudentia mundus regatur?
In fact, throughout the past several weeks, going back to late July, no matter how aggressive the Federal Reserve has postured, how many rate hikes its members like the markets believe are forthcoming, those same markets have been atypically adamant that it won’t matter one bit. The ending is priced the same regardless of the Fed’s influence, today and tomorrow.
The day after tomorrow exceedingly ugly to this point, getting uglier as time goes by.
To give you a small sense of what I mean, the eurodollar futures curve has been grossly inverted since mid-June; top to bottom, its depth has surpassed 100 bps pivoting downward starting from either the December 2022 contract or the March 2023. We haven’t seen anything like this from eurodollar futures, a huge, crucial market, or similar proportions in, of course, US Treasuries, since late 2007.
What this indicates is unusual, historically strong market perception, as close to certainty as we might ever extract from our dynamic world that no matter what the Fed does, however many rate hikes at whatever doses the FOMC chooses, in the very near-term after they’ve finished policymakers will have to turn right around and start cutting.
The only variable seriously considered here is when the “pivot” happens, not if it will or what it will look like. However many more rate hikes are woven into these expectations for this month maybe next, too, the inversion – meaning anticipated outcome – does not change. In fact, eurodollar futures are even more inverted now than they had been at the end of July.
When Paul Krugman – of all people – can sense there’s something really wrong here, there’s something really wrong here. They just can’t figure out where is here.
This is a dollar-led destruction, but not really about the dollar because the dollar ceased to be an important part of the world’s operation a century ago; at least the dollar we all think we know.
But we don’t really know. Hardly anyone has given it a second thought, even after all that fuss and bother fourteen, fifteen years ago. Hell, up until this year, most people were still convinced the dollar was about to crash (again) if only because that’s what the mainstream, currency war textbook still being used as if 2010 never happened says.
Just put the key in the ignition and step on the gas.
Where do we turn when turning the key doesn’t fire up the engine? Fed researchers. Paul Krugman. Academics who study what happens when Treasuries get sold without once pondering why so many got sold.
All for the lack of four seemingly insignificant letters. The planet has a eurodollar not dollar problem, something altogether fundamentally different. Those at the Fed or those like them have no answers; the mainstream world still can’t figure the right questions. Axel Gustafsson Oxenstierna may have taken this in stride since he had time on his and his son’s side. We don’t have the dollar, the dollars, nor time on ours.
If pundit Krugman, of all people, is suddenly concerned, and concerned enough to lay bare his lack of answers, we’re way beyond quaint Latin phrases no matter how timeless and appropriate. Money curves aren’t really like cars, though, they’re like clocks.