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Posted 7/25/2005
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Will China's float sink the housing bubble?
China's first step in revaluing its currency means it and the rest of Asia will need to buy fewer dollars and fewer Treasurys. That's negative for the dollar and the U.S. housing market.
By Bill Fleckenstein
Last Thursday brought with it big financial news: China finally stepped up to the plate and abandoned its dollar peg for a basket of currencies. It's also going to let the yuan appreciate 2.1% versus the dollar in that basket. I'm sure that barrels of ink will be spilled about this event, as there has been so much speculation up to this point about what it would mean.
As far as my opinion goes, I believe the way to think about this is as follows: Change has occurred. It's certainly not bullish for the dollar or for Treasurys. But just how bearish it is, and how long it takes to have any real impact, remains to be seen.
One fact that will determine how much this move matters in the next several months is the percentages of the different currencies in the basket, and how fast the Chinese "fill out the basket." Informed sources that I talked to seem to think that the dollar will be about half the basket, while the euro and yen each may be about 15%, with other currencies mixed in as well. (This is not a fact, just an educated guess.)
Dollar bearish, yellow-dog bullish
But I think that anything that steals a bid from the dollar is not bullish for U.S. financial assets -- given that we spew out a couple of billion extra dollars daily, via the trade deficit, that someone needs to buy.
However, anything that helps to steal a bid from the dollar ought to be bullish for gold.
This move by the Chinese will be mimicked to some degree by the rest of Asia, whose countries have been the ones supporting the dollar and our Treasurys. Since they will need to buy fewer dollars, they'll need to buy fewer Treasurys.
Ramifications for red-hot housing?
That's where it starts to matter to us here in America. If rates trend higher over time -- which they will, all things being equal (though all things never are) -- that will definitely impact the housing market negatively. And, since the housing market, in the form of what I call the housing ATM, is the economy, it will matter to the economy and, by extension, the stock market.
Related news and commentary on MSN Money
But the key is, over time. We just don't know how long all this will take to play out. Of course, market participants can come to conclusions and accelerate the process, or decide it's a nonevent and, in the short term, thwart the process. In fact, the conclusion of the marketplace, in the short run, will probably be more important than whatever it is that the Chinese actually do, especially given the leveraged nature of bond-market speculation.
To my mind, we don't know more than we actually do know. We don't know for sure what the composition of the basket is. We don't know how fast the Chinese will try to implement the changes. We don't know long it will take for the negative consequences to unfold. Therefore, the course of action is to just be alert for clues that this change is starting to matter.
Gold standard vs. a substandard Fed
Turning to the world's oldest currency, gold, the most important reason to want to own it is that imbalances in America will undermine the dollar, the greenback's recent rally notwithstanding. That opinion is not a revelation, of course, as I have noted in many of my past columns. So, I was quite taken aback to see how Greenspan, in his recent Humphrey-Hawkins testimony, graded himself and other central bankers in their management of currencies.
When asked by a member of the House Financial Services Committee last Wednesday if there would be any benefit in returning to the gold standard, Greenspan came up with one of the most incredible utterances in all his tenure:
"I don't think so, because ... since the late '70s, central bankers have behaved as though we were on the gold standard."
He seems to think that Japan's stock and real estate bubble, as well as our own, would have happened just as they did if we'd been on the gold standard, and we would have managed to arrive at this same point of economic/financial disequilibrium.
However, that is absolutely false. Consider only the string of successively bigger U.S. trade deficits. Under a gold standard, we would have had to settle up with our creditors in bullion, not paper dollars. Which means that we would have run out of money -- real money -- long before we could have dug ourselves into our current debt predicament.
A friend who'd forwarded the above quote noted that if we were still on the gold standard, we would only remember Alan Greenspan as a particularly poor economist, rather than Mr. Bubbles. I happen to agree.
The Greenspan of the '20s and '30s
For years, I have been rather vocal about Greenspan and the problems he has caused. Recently, after reading one of my daily columns on that theme, another friend forwarded a quote by Peter Drucker (from an interview in Business 2.0), in which he was queried about the effectiveness of the Federal Reserve today. I thought his answer was as brilliant a response as one could have, especially his conclusion:
"The Alan Greenspan of the 1920s and 1930s was Montagu Norman, the governor of the Bank of England. He had the same reputation as Greenspan has now. But he lost it with the Depression, the same way Greenspan will lose his. The idea that the Federal Reserve chairman has power is a delusion. The only power he has is over the interest rate, and the interest rate has ceased to be important because businesses are no longer dependent upon borrowing from banks. The interest rate is only important to the stock market, to people that short or buy on margin. For the economy -- yes, if it goes up to 18% or down to 2%, but half a point is a symbolic gesture. The Fed has control only as long as people trust that when Greenspan opens his mouth, it is meaningful. But the first time it does not work -- well, magicians get no second chance."
I think that sums it up better than I could ever hope to. I have exhausted the adjectives to describe his simultaneous display of arrogance and cluelessness. I can only repeat my oft-asked rhetorical question: How can this most irresponsible, incompetent Fed chairman in history have any credibility whatsoever?
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com Web 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 MSN Money.
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