Monday, July 23, 2007

The Biggest Dollar Diversifiers Are American / S. Jen

While i not agree that the US $ is sound Stephen Jen puts up some excellent points why the Greenback is facing some "hidden" headwinds. The obvious problems like a slumping US economy, the diversification from Foreign Central Banks away from the $, deficits etc are well known ... He points out several others reason why the $ is losing faith..... He blames the Fed and its "bailout" mentality under Greenspan and probably under Bernanke.... On top of this it isn´t helping the $ when the Fed is the only Central Bank that is targeting the useless "core rate" when others are fighting the headline CPI. Both are not very successful...... But the key point is that the big guys are fleeing or as Wall Street and others would say "diversifying" out of the dollar holdings at a accelerating pace........Make sure you read also this piece from Brad Setzer

Obwohl ich nicht mit der These übereinstimme das die Fundamentaldaten für den $ immer npch gut sein sollen macht Stephen Jen hier einen sehr guten Job und weist auf einige nicht so offensichtliche Punkte hin die einen Teil der aktuellen Dollarschwäche erklären. Die offensichtlichen Probleme des $ wie eine abschmierende Volkswirtschaft, Diversifikation der Notenbanken aus dem $, Defiizite usw. sind inzwischen selbst auf CNBC angekommen. Jen aber arbeitet andere nicht so offensichtliche Punkte heraus, wie z.B. das die Fed dank Greenspan zurecht eine Mentalität unterstellt das im Falle einer Krise immer die Geldschleusen großzugig geöffnet werden. Dazu kommt dann noch das die Fed die einzige Notenbank ist die lediglich die alberne "Core" Inflation "bekämpft". Der wichtigste Punkt aber ist das die Amis selbst aus dem $raum flüchten oder vornehmer ausgedrückt "diversifizieren"..... Kann Euch in diesem Zusammenhang noch empfehlen das von Brad Setzer zu lesen.

The dollar is very weak relative to most currencies. While cyclical factors have played an important role, I don’t believe that cable is trading at 2.05 and EUR/USD at 1.38 due only to these rather innocuous cyclical factors. Other structural factors may be at play. One possible structural reason for the dollar to have had a gradual downward trajectory since 2002 is, I suspect, portfolio diversification by US real money managers.

Cyclical explanations for the weak dollar
There are ample cyclical reasons for the dollar to have underperformed recently. First, the US economy is weaker than almost every other economy in the world. Though we may have seen the trough in the US business cycle in 1Q, the recovery trajectory is likely to be modest, after a surge in 2Q. The rest of the world, however, continues to surprise to the upside, showing no sign of lagged effects of the softness in the US economy from 2Q06 to 1Q07. No longer do investors doubt the ‘de-coupling’ thesis. Monetary policy between the Fed and other central banks is in direct correspondence to this expected divergence in economic growth. As a result, the dollar may sag as long as other central banks remain in motion.
Second, in addition to these central case expectations of the US and the rest of the world, due to the problems with the sub-prime market and the housing sector, the risk to the US outlook is biased to the downside, with limited spillovers expected for the rest of the world. Investors have the collective memory that the Federal Reserve eased interest rates by 75bp in 1998 in response to the failure of LTCM, despite the fact that the general macro conditions were positive and inflation was drifting higher. With this track record, investors believe that the Fed may have difficulties raising interest rates if the sub-prime problem persists.
Third, higher oil prices are positive for EUR/USD. Not only do oil exporters have a marginal propensity to consume European goods that is twice as high as that for US-made goods, but the fact that the ECB targets headline inflation while the Fed targets core inflation may also have encouraged investors to expect EUR/USD to rise with oil prices. ....

Diversification by US real money accounts
While the cyclical factors I mentioned above may help explain why the dollar has depreciated recently, they don’t give a satisfactory explanation as to why the current level of the dollar is so extremely low. In retrospect, since 2002, the dollar has had its ups and downs, but the underlying trend has been downward. I have long argued that the dollar is structurally sound, and provided reasons (such as the ‘de facto dollar zone’, valuation, geopolitical hegemony, dominance in the global financial markets, etc.) justifying why the dollar’s hegemony will be preserved. I am still convinced by many of my arguments. However, I am now taking more seriously the thesis that US real money investors have been steadily diversifying away from USD assets since 2003. ...The dollar may thus still be structurally sound, but not as sound as I had thought.

US real money accounts consist of four key categories of funds: mutual funds, private pension funds, state and local pension funds and life insurers. The Fed’s Flow of Funds data track the sizes of these funds. As of 1Q07, the total assets under management by these four categories reached US$20.7 trillion, up from US$12.6 trillion in 1Q03. At more than US$20 trillion, real money under management in the US is close to four times the size of the world’s official foreign reserves. Any signs of diversification by these real money accounts would have great implications for the dollar. While I don’t have a breakdown of the asset allocation of all four categories, the Boston Fed’s Monthly Mutual Fund Report shows that mutual funds’ allocation to international equities has risen from around 15% in 2003 to 22.5% now. This trend diversification is gradual but determined.

If we apply this outward investment allocation ratio to the total stock of mutual funds, the cumulative outflows of mutual fund investment since 2003 are around US$400 billion. But if we apply this outward investment allocation ratio to the entire stock of real money accounts, the cumulative outflows since 2003 total US$1.16 trillion: US$190 billion in 2003, US$295 billion in 2004, US$324 billion in 2005 and US$352 billion in 2006. These outflows are indeed massive.

Bottom line
Contrary to popular presumption, US real money mangers are the biggest dollar diversifiers, not the Asian central banks. Controlling assets that are four times the size of the total global official foreign reserves, US real money managers have been steadily diversifying out of the US since 2003. My calculations show that cumulative outflows may have totaled US$1.16 trillion in the past four years. This may help explain the downward drift in the dollar in recent years, and why the dollar is so weak now.

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Anonymous Anonymous said...

I do not see why Jen has to guess these numbers, doesn't he have the resources of one of the worlds leading IBs to jig up some hard data?

3:17 AM  
Blogger jmf said...

Thats a good point!

3:21 AM  
Anonymous Anonymous said...

No longer do investors doubt the ‘de-coupling’ thesis.

I'm not so sure about that, although no doubt demand from China will support 'emerging markets' should the US falter badly ('emerging markets' being overly dependent on commodity exports). On the other hand, one could ask: Who is China's main customer? It reminds me of, and sounds a lot like, the 'new paradigm' talk from the late 1990s: non-stop economic and productivity growth via technology, and along with that continuously, even spectacularly, rising equity markets.

Not to be some kind of super bear, but one should at least consider the possibility that this kind of talk is a sort of contrarian indicator.

Anyway, this kind of skepticism is best not completely discounted or ignored.


10:58 PM  
Anonymous Anonymous said...

To put it in more concrete terms:

I still tend to believe that there will be a time in the future when being short emerging markets will be very profitable. No sure exactly when, though.


11:10 PM  
Blogger jmf said...

Moin Eh,

the only reason i´m not tempting to short the emerging markets is that the opportunities mainly in the US and other developed countries are far more obvious...

I think the liquidity still favours the EM.

China just hits a new high today......

10:35 AM  

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