The Capital Note

The Capital Note: Dollars & Lumber

An inspection of a sheet of $1 bills at the Bureau of Engraving and Printing in Washington, D.C. (Gary Cameron/Reuters)

Welcome to the Capital Note, a newsletter (coming soon) about finance and economics. On the menu today: dollar weakness, lumber strength, and a look at John Law’s Mississippi bubble.

Dollar Weakness

When the dollar is weak against the British pound, it says something. The British economy took the biggest hit of any OECD country in the second quarter (a quarter-on-quarter decline in GDP of 20.4 percent, compared with an OECD average of 9.8 percent), the country’s government gives every impression of being adrift, and there is no sign of a trade deal with the E.U. as the U.K. approaches the end of the Brexit transition period.

And yet, a pound now buys a little over $1.34, against about $1.31 at the beginning of the year (sterling fell as low as $1.15 at the peak of corona-panic in mid-March, and this time a year ago a pound was worth only $1.21).

It is a similar story with the euro. The single currency bottomed out around $1.08 in mid-March, and this time a year ago was trading at $1.10. Now it is worth around $1.20, quite a move even allowing for an earlier run of dollar strength.

The Financial Times:

The dollar came under renewed pressure on Tuesday as investors grappled with the impact of the Federal Reserve’s policy shift on inflation and choppiness in the US economic recovery…

Investors pointed to the US central bank’s recent announcement that it was willing to tolerate periods of higher inflation to make up for a persistent undershooting of its longstanding 2 per cent target, and that low unemployment itself will not drive policy action.

Taken together with the unprecedented fiscal support ushered in by Congress and the uneven US economic recovery, the dollar was likely to depreciate further “in all but the most extreme” scenarios, said Gene Frieda, a global strategist at Pimco.

“The Fed’s aggressive monetary policy response has eroded the dollar’s yield advantage built up over a multiyear cycle of rate hikes . . . This advantage is unlikely to be restored anytime soon,” he added.

I also wonder whether, as discussed in yesterday’s Capital Note, concerns over a possibly chaotic election in November are also beginning to weigh on the dollar.

It is worth noting one additional detail in the FT’s report: that the euro’s gain was despite the currency union reporting the first year-on-year fall in consumer prices since 2016.

But The Financial Times reports:

Zach Pandl, an economist at Goldman Sachs, said that the European Central Bank appeared unlikely to push back on euro appreciation with rate cuts as it usually would, instead prioritising efforts to internationalise the currency after agreeing on an EU recovery fund.

Mr Pandl believed the EU’s plan to issue €750bn of bonds, in addition to other issuance tied to separate loan programmes, could help to boost the euro’s share of global foreign exchange reserves to 24 per cent from its current level of 20 per cent.

“In light of recent institutional upgrades, the euro may be an increasingly attractive alternative for global investors looking to diversify away from the US dollar,” he said.

There may be something to that. One longstanding reason for the creation of a single currency was resentment within the EU (and its predecessors) over the ‘unfair’ advantage that having the world’s de facto reserve currency gave to the U.S. Perhaps now the EU sees its moment, although with the US dollar still accounting for nearly 62 percent of global foreign exchange reserves, Brussels’ vampire currency still has a way to go.

Over at his website Daniel Lacalle notes that, taking a broader perspective, the dollar has strengthened on a trade-weighted basis this year. He also notes that “[t]he Bank of International Settlements report[ed] in its June 2020 report that global US-dollar denominated debt is at a decade-high.”  In Lacalle’s view, the greenback’s weakness against the euro (and the yen) is “based on optimistic expectations of European and Japanese economic recovery”.  I’d rather look at the reaction to the Fed’s policies as the main explanation, but I certainly suspect that those hoping for a string euro zone recovery will be disappointed.

As always with currencies, who knows, but I would be keeping an eye on November.

— A.S.

Lumber Strength

If you were thinking of using work-from-home as an opportunity to undertake a home-improvement project, think again. The price of lumber hit an all-time high this week, touching $830 per board before receding to roughly $730.

While the prices of many commodities, most notably oil, have dropped during the pandemic, lumber is in high demand by homeowner availing themselves of extra time at home. Further contributing to the rally is a supply reduction — partially the result of a deliberate decision by lumber mills, partially because of pandemic-related mill shutdowns.

From LBM Journal:

Mills made dramatic reductions to production schedules in the second quarter in anticipation of sharply lower demand as states instituted shelter-in-place orders and unemployment surged. The anticipated decline in demand never materialized. To the contrary, housing starts surged 60% between April and July to nearly 1.5 million units (SAAR).

Interest rates also come into play, as always. Record-low mortgage costs have led to a boom in the home-construction market. Meanwhile, restaurants and bars across the country are building outdoor-dining facilities

Other commodities, including meat and poultry, experienced supply scares in the spring as producers closed plants. Whereas those markets stabilized, lumber may be an outlier:

Mill owners said it is unlikely they will be able to add much more wood to the market given the time lost when many mills were shut down in March and April and the challenges of operating mills in the midst of the pandemic.

— D.T.

Around the Web
Someone appears not to believe in that V.

Bloomberg:

Capital One Financial Corp. is cutting borrowing limits on credit cards, reining in its exposure as the U.S. reduces support for millions of unemployed Americans.

The adjustments, which the company said it makes from time to time, set off a swift outcry on social media. Some customers have complained in recent days their limits have been slashed by a third to two-thirds, eroding their ability to borrow in an emergency during a pandemic or potentially hurting their credit scores.

But in China…

Results of a private survey on Tuesday showed China’s manufacturing activity expanded in August at the fastest pace in nearly a decade.

The Caixin/Markit manufacturing Purchasing Managers’ Index (PMI) came in at 53.1 for August, compared to 52.8 in July.

Economists polled by Reuters had expected Caixin/Markit manufacturing PMI to come in at 52.7.

PMI readings above 50 indicate expansion, while those below that level signal contraction. The readings are sequential and indicate on-month expansion or contraction.

Always keen on a bad idea, California is contemplating a wealth tax. It says something that the (formerly) Golden State may well be beaten to the punch by those paragons of fiscal virtue down in (checks notes) Argentina.

MercoPress:

Argentina’s ruling coalition, Frente de Todos, is seeking to impose a one-time tax on wealthy citizens as part of a strategy to solidify the alliance’s populist credentials while boosting government revenue amid a deteriorating economic crisis.

The so-called “solidarity” tax would apply to approximately 12,000 Argentines that have over 200 million pesos (US$ 2.7 million) in assets, according to a statement by the coalition’s press office in the lower house of congress, where the bill was presented last Friday. The tax would scale up to as much as 5.25% for ultra-wealthy citizens holding their fortune in assets outside the country, it said…

The wealth tax is also likely to be part of Argentina’s negotiations with the International Monetary Fund for a new program that will replace a failed US$ 57 billion bailout given to the country in 2018. Economy Minister Martin Guzman sent a formal letter to the IMF this week requesting to begin negotiations.

Random Walk

A veteran investor once told me (a long time ago) that the first book that I needed to read relating to his profession was Charles Mackay’s wonderful Memoirs of Extraordinary Popular Delusions and The Madness of Crowds (1841).

This is the first time an extract from this book has appeared in The Capital Note. It will not, I suspect, be the last. This particular extract concerns John Law’s Mississippi bubble.

For some reason, it seemed relevant:

Thus the system continued to flourish till the commencement of the year 1720. The warnings of the parliament, that too great a creation of paper money would, sooner or later, bring the country to bankruptcy, were disregarded. The regent, who knew nothing whatever of the philosophy of finance, thought that a system which had produced such good effects could never be carried to excess. If five hundred millions of paper had been of such advantage, five hundred millions additional would be of still greater advantage. This was the grand error of the regent, and which Law did not attempt to dispel. The extraordinary avidity of the people kept up the delusion; and the higher the price of Indian and Mississippi stock, the more billets de banque were issued to keep pace with it.

The edifice thus reared might not unaptly be compared to the gorgeous palace erected by Potemkin, that princely barbarian of Russia, to surprise and please his imperial mistress: huge blocks of ice were piled one upon another; ionic pillars, of chastest workmanship, in ice, formed a noble portico; and a dome, of the same material, shone in the sun, which had just strength enough to gild, but not to melt it. It glittered afar, like a palace of crystals and diamonds; but there came one warm breeze from the south, and the stately building dissolved away, till none were able even to gather up the fragments.

So with Law and his paper system. No sooner did the breath of popular mistrust blow steadily upon it, than it fell to ruins, and none could raise it up again.

— A.S.

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