[DEBATE] : The race to the bottom has begun

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Ambrose Evans-Pritchard: The race to the bottom has begun

Submitted by cpowell on 06:22PM ET Sunday, August 17, 2008. Section: 
Daily Dispatches

Dollar Surge Will Not Stop America From Feeling Effects of Global Crunch

By Ambrose Evans-Pritchard The Telegraph, London Monday, August 18, 2008

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/18/ccview...

Two alerts landed on my desk this weekend from the elite markets team at 
Goldman Sachs. One was entitled "The Dollar Has Bottomed!" Those betting 
on an imminent disintegration of American economic and political power 
may have to wait another cycle. Rival hegemons are falling like ninepins.

The US dollar index hit an all-time low in March. It crept slowly 
upwards in the early summer before smashing through layers of resistance 
over the past month.

The surge against sterling, the euro, the Swiss franc, and the 
Australian dollar is one of the most spectacular currency shifts in half 
a century. "Something fundamental has changed," said the bank. Indeed.

US industry is now super-competitive, if small. Mideast funds are 
drawing up shopping lists of Wall Street takeover targets. Airbus and 
Volkswagen are shifting plant to America to escape crushing labour costs.

US exports have risen 22 percent over the past year, outstripping 
Chinese growth. The US non-oil trade deficit has shrunk by two fifths 
since 2002. It is now running at $300 billion a year. This is 2.1 
percent of GDP.

The other note advised clients to "Take Profit on Globalization Basket," 
especially on eastern European currencies. Goldman Sachs has quietly 
dropped its talk of $200 oil. Even Russia's petro-rouble is now deemed 
suspect.

The twin missives more or less sum up the dramatic change in mood 
sweeping financial markets since it became evident that the entire bloc 
of rich OECD countries has succumbed to the delayed effects of the 
credit crisis.

Japan contracted by 0.6 percent in the second quarter, Germany by 0.5 
percent, France and Italy by 0.3 percent. Spain recalled the cabinet 
last week for an emergency summit. New Zealand and Denmark are in 
recession. Iceland contracted at a catastrophic 3.7 percent in the 
second quarter.

"The whole decoupling thesis has started to come apart at the seams," 
said David Bloom, currency chief at HSBC. "Canada is frozen over. We 
have Arctic conditions in Sweden, and the UK is falling off the white 
cliffs of Dover."

The UK economy is not my brief, but I see that hedge funds are 
circulating a report from the US guru Jeremy Grantham predicting a very 
bad end to Gordon Brown's debt experiment.

"The UK housing event is probably second only to the Japanese 1990 land 
bubble in the Real Estate Bubble Hall of Fame. UK house prices could 
easily decline 50 percent from the peak, and at that lower level they 
would still be higher than they were in 1997 as a multiple of income," 
he said.

"If prices go all the way back to trend, and history says that is 
extremely likely, then the UK financial system will need some serious 
bailouts and the global ripples will be substantial."

For months the exchange markets ignored this impending train crash, just 
as they ignored the property bust in Europe's Latin Bloc, or the little 
detail that UBS alone had just lost the equivalent of 8 percent of 
Switzerland's GDP. All they cared about in the currency pits was the 
interest rate gap: US low, Europe high.

Now the paradigm has flipped. The Fed may have been right after all to 
slash rates to 2 percent. The European Central Bank may have panicked by 
tightening in July. Note that the elder Swiss National Bank did not do 
anything so rash.

Bulls now believe America is turning the corner. Financial stocks are up 
20 percent since early July. Some "monoline" bond insurers have risen 
1,200 percent in a month as fears of Gotterdammerung give way to sheer 
intoxicating relief, and a "short squeeze." Such are bear-trap rallies.

Regrettably, I remain beset by gloom. The US fiscal stimulus package 
that kept spending afloat in the second quarter is running out fast. 
There is nothing yet to replace it. The export boom cannot keep adding 
juice as the global crunch hits. My fear is that the US will tip into a 
second, deeper leg of the downturn, setting off a wave of savage job 
cuts. This will start to feel more like a real depression.

The futures market is pricing a 33 percent fall in US house prices from 
peak to trough, based on the Case-Shiller index. Banks have not come 
close to writing off implied losses on this scale.

Daniel Alpert from Westwood Capital predicts that a mere 28 percent fall 
would alone lead to a $5.4 trillion haircut in US household wealth, and 
leave lenders nursing $1.25 trillion in losses. So far they have 
confessed to less than $500 billion.

Meredith Whitney, the Oppenheimer's bank Cassandra, predicts a gruesome 
40 percent fall in prices. If so, expect prime borrowers facing negative 
equity to start throwing in the towel en masse. "I do not think we are 
near the end of writedowns. I continue to see capital levels going 
lower, and stocks going lower," she said.

So no, this painful ordeal is far from over. We are not witnessing a 
dollar rally so much as a collapse in European and commodity currencies. 
The race to the bottom has begun in earnest.

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