"Ka-Poom Theory" Chart as originally posted February 1999
currencies are primarily valued by the relative economic strength
among trading partners with floating currencies, except for the
major component of dollar strength is the
unique demand for dollars due to the dollar's reserve currency status.
demand and thus price is supported by
all nations trading with the U.S. and among each other as all need
dollars for international exchange,
especially for oil.
dollar reserve currency status declines, either gradually via euro
diversification or suddenly due to an event that causes a loss in
confidence in the future purchasing power of the dollar, dollar demand
and value declines in kind.
interest rates are low mostly due to
demand for U.S. debt, denominated in dollars, from foreign central
banks of nations, especially
Asian, that seek to keep U.S. consumers borrowing at low interest rates
to purchase their exports using strong dollars; Asian "vendor
Ka: A random
exogenous event (e.g., a stock
market crash predicted in 1999 for year 2000 and recession predicted
for 2001) intensifies disinflation
created by Asian vendor financing, causing the Fed to
shift from bubble fighting to anti-deflation polices.
responds with an excessive cheap money policy,
targeting short term rates below the inflation rate.
Fed keeps interest rates too low for too
long, creating a new asset bubble. But in what? We did not
know in 1999. The answer: real estate.
A random or not
so random exogenous
event that has not yet happened (the stock market crash we predicted
for 2000 did not have the impact we expected) exposes the true level of
risk to lenders that is inherent in
this unbalanced system, causing lenders to lose confidence in the
future purchasing power of the dollar and seek alternative reserve
rates and inflation rise rapidly as
dollar demand and value falls, import prices rise, and the Fed moves to
raise rates to stem the tide or dollar repatriation.
The first foreign
central banks to move will be those with the least exposure to losses
in national income from sales of exports to the U.S. or depreciation in
the value of the dollars they are holding as reserve assets (e.g.,
Not surprisingly, the
Fed disagrees: "To sum up, this analysis suggests that there is
more to solving the conundrum of the recent low long-term interest
rates than pointing to the behavior of official foreign purchases of
U.S. Treasury securities. Indeed, there is little solid evidence
suggesting a persistent relationship between the two. Furthermore, the
structure of the Treasury market does not support the projection of a
rapid rate hike in the event that foreign central banks retreat from
the U.S. Treasury market." The
Long-term Interest Rate Conundrum: Not Unraveled Yet?
assertion of no persistent relationship exists between low interest
rates and foreign purchases of U.S. Treasury securities contradicts the
fact that Central
Bank reserve diversification spooks currency traders, and will
drive the dollar down, which is in fact finally causing U.S. inflation
and interest rates to rise.
Fed continues to raise rates, but not to fight inflation caused by
economic overheating. The Fed needs to demonstrate anti-inflation
vigilance to foreign lenders so they will continue to fuel the foreign
capital addicted U.S. speculative financial system, but raises rates at
the risk of throwing the real economy into recession.
Unfortunately, it’s a lose-lose proposition. Eventually the
hikes, either too many or too few -- the Fed never gets it right --
will produce either a enough recession or inflation to spook foreign
investors and start the Poom ball
mechanism of Ka-Poom Theory proposed in 1999 appears happening, albeit
than we predicted, and slowly versus suddenly. At least so far.
resulting inflation is an event 25 years in the making, and will be
historic in its extent.
Update March 9, 2006 to account for the Housing Bubble