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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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U.S. stocks were now 58 percent of the value of all stocksA study conducted in 2001 showed that, thanks to the redoubtable Margaret Thatchers imposition of prefunded pension plans on employers, the share of Britains GDP represented by pension fund assets is hugely higher than the minuscule accumulation of pension investments in the eurozone. Although its authors did not draw any conclusions, I was struck by the realization that if Britain does not join the eurozone quickly, it will not be able to afford to join it later, because the taxation implications for the euro countries of the Baby Boomers retirements will be drastically higher than those facing Britain, and members of the eurozone are under annual pressure to harmonize their taxation levels. When, all of a sudden, a whole gaggle of new pension fund investors appears, loaded with money, what would those high-living investment advisers do? They would explain to all these eager new committees how they make money for their clients by investing globally, more or less in the following terms: Its all quite simple, really. Two-thirds of global equities are in the United States and Japan. Our firm did brilliantly in the 1980s by overweighting Japan and underweighting the United States (according to the MSCI Global benchmark). That way we caught the strongest currency and the strongest stock market: no surprise that those factors go together. We have done brilliantly in the 1990s by underweighting Japan and overweighting the United States. Furthermore, within the United States, weve overweighted technology stocks, because the hottest tech companies are located there. So weve once again overweighted the best currency and the best stock market. Thats why you should let us invest for you. As for the rest of the world, we try to match or exceed EAFE returns by venturing into interesting emerging markets, such as South Korea, Brazil, and Taiwan. From 1995 to 2002, such firms delivered roughly one-third of their investment returns to European and Asian clients from the huge rally in the dollar; the rest came from stock market performance. What happened in late 2001 was that global investors, who had been worrying about an overvalued dollar for some years, finally began to conclude the game was up: ? U.S. stocks were now 58 percent of the value of all stocks in the world, up from 24 percent at the dawn of the 1990s. Roughly onethird of that increase had come from currency. ? The price-earnings ratio in the United States was the highest in the industrial world, and the U.S. economy looked to be among the most vulnerable to a global slowdown because of its excessive reliance on technology. ? It had become apparent that Nasdaq was the greatest mania of all time, and this meant that those European inflows that had boosted Nasdaq in 1999-2000 would ultimately reverse. ? Although 9/11 was a horrendous shock, and though it soon became apparent that some al Qaeda supporters lived in the Moslem communities of Europe, it was also soon apparent that the War on Terror was a war between the United States and Britain on one side and Islamic radicals and such threats as Saddam Hussein on the other. This meant that the United States was likely to be the primary focus of any major new terrorist attacks. To sum up: The great global players who had been such big boosters of the dollar through the 1990s became frightened of their dollar and U.S. equity exposure in late 2001 and 2002, creating a new long-term threat for the dollar. WHAT DOES A DOLLAR BEAR MARKET DO TO AMERICAN ASSETS? Obvious answer: It makes them much less attractive to foreign investors. A more complete answer: It makes them much less attractive to the group of investors who have the most savings available to invest. Even less obvious answer: It makes them much less attractive to the group of investors who increased their exposure to U.S. assets most heavily at and near the top of the twin bull marketsNasdaq and the dollar. These investors have been, therefore, huge losers to a degree even bruised Americans havent suffered. They lost on the stock market, and also lost on the currency. History tells us that major currency moves take years to play out. The dollar experienced a bear market in each decade since the 1950s, but it escaped through the 1990s. In reality, it simply deferred the inevitable until 2002 and beyond. This time, the consequences could be worse than the sudden dollar bear in 1987 that crashed the stock market 22.6 percent in one day. Then the dollar started to break free from its Louvre support, and eurodollar holders started switching into other currencies. The reason: It was revealed that the U.S. Current Account deficit had climbed to roughly $79 billion a year. To accumulate a $79 billion trade deficit now takes less than two months. In 2003, the eurodollar overhang has reached proportions that seem almost apocalyptic compared to the problems of the 1980s. So if eurodollar holders were to decide, en masse, that they cant take the currency losses any longer, the squeeze on the U.S. financial system could be on a scale unlike anything ever seen before. The reader may well grumble, Stop muttering about vague threats! Give us the data on these blasted eurodollars! The problem is, I cannot. Nor can anyone else I know. Ive asked all the leading economists, Federal Reserve governors, and major global investors I meet whether they have any data. Everyone says current data dont exist: The principal source of global financial liquidity is a largely unknown quantity. I understand, however, that major banks in the U.S. banking system now routinely rely on eurodollar funding for 30 to 50 percent of their corporate loans, which is worrisome when one realizes the other side of those transactions is a collectivity of foreigners who have no legal requirement to hold dollar deposits, and who face serious currency risk. For those reasons, I have long believed that the next serious Baby Bear attackone that could easily become a Papa or a Mamawill come from a runaway breakdown in the eurodollar market. Fred Bergsten, the distinguished Washington economist, recently told Congress that the dollar is the third bubble. (The other two bubbles he mentioned were tech stocks and the stock market generally.) He sees no way that the Current Account problems can be resolved without a contraction in the dollars value and a rise in American savings, and warns that the adjustment process could be painful. What will happen to the value of U.S. financial assets if foreign investors refrain from outright panic but just refuse to inject new funds into dollar-denominated assets? No Wall Street strategists consider that a risk. They point to the depth and liquidity of U.S. capital markets, and say there are no serious alternatives abroad. Japan is sinking slowly into a bog; the eurozone is mired in red tape; China is booming, but its capital markets are rigidly controlled; Canada, Australia, and New Zealand are only about 4.5 percent of the global index. So like it or loathe it, youve got to be in the dollar and in U.S. markets. I guess I would be more convinced of this argument if I had not heard it before. In the late 1980s, Japan was on its way to global economic dominance. It had become the price and quality setter in a wide range of industries. It could buy any foreign asset it wantedwhether a Van Gogh or a Rockefeller Centerif it were for sale. And then it was all over. CAN THERE BE GOOD NEWS FROM A DOLLAR BEAR? In one sense, a dollar bear is like global warming, which could produce widespread deleterious effects on the environment. But on the plus side, global warming also means longer growing seasons in the temperate zones, helping to explain why world food output has tended to be above forecasts during the 1990s. Similarly, a dollar bear could be just what a global economic doctor might order as a bracing tonic. Because the dollar is the global reserve currency, when it falls in value, global inflationary forces get a boost. That could be just what the world needs at a time of powerful deflationary drag emanating from Asia and Japan. A third bonus from a dollar bear: Oil is denominated in dollars. Most industrial nationswith the exception of Canada, Australia, Britain, and Norwayand most Third World nations import some or all of their petroleum needs. It was bad news for the global economy in 2001 when oil prices and the dollar rose in tandem. But the dollars break has been very good news for many countries that lack indigenous hydrocarbons. A fourth benefit: A major dollar bear move would be great news for most U.S. manufacturers. They are suffering ruinous competition from Asia and Japan, and the sky-high dollar has been another ineradicable problem. They incur their costs in the worlds most overvalued currency, hardly a recipe for global competitiveness. If the dollar can slide gently down to its trading valueand stop behaving as a financial currencythe U.S. Midwest in particular would greatly benefit. Fifth and last, a fall in the dollar can be good news for U.S. multinationals. Some great U.S. corporations, such as Johnson & Johnson, IBM, and Intel, earn a large proportion of their profits abroad. When those earnings are restated into rising dollars, then companies overall earnings shrink. Again, a gently sliding dollar would be good news for most multinationals. How can you profit from a dollar bear? Most obviously, by investing in gold and in gold mining stocks. You then own a pre-Bretton Woods store of value. As long as the dollar remains in a bear market, gold remains an extremely attractive asset. What the investor should watch is the dollars trend and the TED spread, to see if foreigners are giving up on the greenback. If they are merely cutting back on their new commitments, this could be a good outcome for the U.S. economy and most U.S. equities. To sum up, the U.S. economy and financial system are the financial equivalent of a patient on a dialysis machine hooked up to foreign suppliers. The relationship is symbiotic: They finance us, and we buy goods from them and travel to their countries, and, historically, we have been the guarantors of their liberty (although they dont talk about that so much anymore). There is no historical precedent for a relationship on such a scale. Therefore, there is no sure way to predict how it will endor even whether it will end at all. No long-term investor survival plan would be complete if it did not make allowance for two possibilities: a gradual downward adjustment in the dollars value, and a violent, short-term, TED spread-activating plunge. The expression sound as a dollar went out of date long ago. It is now in the same category as What this country needs is a good five-cent cigar. |
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