The Leading Edge of the Dollar Hurricane

BUCHAREST — If you’ve never been to this town, it is at once Paris on the come and a frayed remnant of Soviet architectural banality. By which I mean, what you see is what you’re inclined to see.

I’ve come to this analogy looking out the window of my quaint, Beaux Arts hotel and seeing 19th-century buildings that I might call “ghetto chic” and in need of some care and cash to restore their glory (I happen to be partial to this city) … while others just see “ghetto” and walk away.

Just depends on what you’re inclined to see.

Bringing this to mind is the Washington Post article I happen to be reading on my phone as I look out over Bucharest. I find myself wondering: What inclinations hide here? What is this reporter not telling me that might provide an analysis fundamentally different from his?

The story he has written is the latest on America’s international trade in goods and services for July, which happened to be released in September. Basically, our trade deficit.

Novocain to the brain, I know. But hang with me a moment. There’s a salient point here that explains why monthly headline numbers and the news coverage you generally get tell you very little about the economic winds swirling around you, or the broader implications, which are, in this case, quite troubling for your near-term future and mine.

This particular Post scribe wants me to know that America’s trade gap narrowed by 11.6% in July — more than forecast, I’m told, so, I guess, salad days are here again, or at least on the way. The value of shipments to overseas customers also perked up — to a 10-month high, no less! That pickup in exports (theoretically a bright spot and around which today’s dispatch ultimately revolves) surged because of food sales.

We’re in high cotton now, dear reader. High cotton, indeed.

Just don’t try selling that cotton to anyone who’s seen the statistics. Nobody who knows how it was made is buying it.

Back in the day, I was a financial reporter at The Wall Street Journal, and when I smelled a rotting fish, my reflexes sent me in search of the source to examine that fish myself.

And so I did. I pulled the Commerce Department’s raw data. And you know what? This fish stinks for a reason…

A Strong Dollar Squeezes Profits

I’ll get to the stink in a moment, but first — who cares?

Exports account for nearly 50% of revenues inside the S&P 500 and, as such, are a key reason the S&P’s operating earnings are down now for seven consecutive quarters — the longest contraction in at least 20 years.

That’s because exports are a primary victim of the strong U.S. dollar. As our Benjamins rise against other currencies, consumers and businesses outside America can afford fewer and fewer products made in America because “American-made” is suddenly too costly in terms of the local yen, euros, pounds, pesos or shekels.

So, fewer John Deere tractors are leaving the showrooms in Brazil. Canadians struggling through a midlife crisis are buying nearly 10% fewer Harley-Davidsons. Just two examples of a larger trend, and the leading edge of the dollar hurricane.

On the backside, the sales that do occur in euros, Brazilian reals and loonies buy fewer and fewer dollars here at home when the cash is repatriated.

Managements running companies such as Deere and Harley-Davidson then do what Wall Street demands — they cut costs to preserve bottom-line profits for crotchety shareholders and trigger-happy money managers for whom a penny’s miss on per-share earnings is a cardinal sin.

As an act of contrition, Deere and Harley-Davidson lay off higher-wage workers (as all three have), and those lost jobs ripple through Uncle Sam’s economy and his GDP slows.

And yet, the Fed and the White House crow about an economy at near-full employment — never mind that the new jobs responsible for near-full employment are largely low-wage jobs mixing martinis and setting up appointments in a doctor’s office.

Now, about that stink the Washington Post was peddling as fresh fish…

Blame China

You see, the month of July isn’t the story of a trade gap narrowing or export values at a 10-month high. That’s like writing the story of the elephant based on its small tail.

Exports did increase by $3.62 billion from June to July, which, one might surmise, has Uncle Sam’s economy moving in the right direction at least. Alas, no.

Nearly $3.56 billion of that increase was due to unexpectedly large shipments of soybeans, primarily to China as the Middle Kingdom manages what is apparently a pork shortage. China operates the world’s largest “strategic pork reserve” (no, really), and hogs grow fat on soybean meal, yet China’s soy production has suffered of late.

The rest of the month’s data … not so great.

But even that’s not the real point.

Beware the Fed’s Pied Piper

At the other end of the elephant’s tail is the broader impact of the strong dollar over time, since one month does not a trend make. A trend makes a trend, and the trend of American exports in a strong-dollar world is depressing.

Exports of American goods and services are down nearly $64 billion so far this year. Every primary category is sucking on a barrel of red ink — foods, feeds and beverages; industrial supplies and materials; capital goods, except automotive; automotive vehicles, parts and engines; and consumer goods.

All down.

For 19 consecutive months on a year-over-year basis.

That we might rightly call a trend.

Yet the $64 billion in lost exports is but a 5% decline from a year ago. Yet even that pittance is imposing huge costs on the economy. Imagine the impact to Deere and Harley-Davidson if the dollar strengthens more.

That is context for every Federal Reserve meeting from here on out, which is context for the two biggest risks in the global economy today … the U.S. dollar and Fed policy.

Into this trend various members of the Fed sing a song of an economy healthy enough to handle higher borrowing costs. Various economists hum along to the same nonsense. Wall Street dances to the lovely tune.

Maybe you remember, dear reader, that the Pied Piper led rats and children to their deaths in 13th-century Saxony with enchanting music.

Sure, interest rates need to rise. Rates should never have been this low to begin with. But they are low because of government profligacy and hideous Fed policy back into the 1980s.

Low rates have perverted savings and investment patterns. They’ve stolen wealth from righteous savers and showered it upon wastrel borrowers, most particularly the bloated Western governments. And they’ve blown ridiculously large bubbles in stocks, bonds and real estate. Those will burst.

That’s guaranteed.

It won’t be pretty.

See, the world is addicted to low-rate dollar debt. It’s the opiate of corporate, consumer and governmental masses who always need just one more hit to make the pain go away. Companies from Ukraine to Brazil to Malaysia have been mainlining the stuff by the trillions for a nearly a decade now.

Raise interest rates in America and you’ve got yourself a problem that potentially spins our current mini-depression into a Greater Depression.

Higher rates mean the debt-addled face higher — potentially debilitating — debt-repayment costs. It means foreign companies must now sell more of whatever they sell locally to generate ever more local dinero that they need to buy ever more dollars to make their dollar-debt payments. It means foreign governments must raid their piggy banks.

Can’t sell enough to generate the needed dollars? Not enough coins in the piggy bank? Bonds default. Local banks crumble and send local stock markets diving. Local currencies crash.

Will we get a debt or currency crisis somewhere in the world that spills over globally and ransacks the American economy again? Who knows? But if you mix gunpowder with a spark, you get an explosion whether you want it or not.

Just something to think about when you hear Fed officials and economists singing lovely songs of an economy that can shoulder higher interest rates … or when you’re reading the day’s fishwrap telling you America’s export numbers are at 10-month highs.

The Sovereign Investor
September ,8 2016