Timing The Exit As Competitve Devaluation Looms; Is The Euro 25% Overvalued? More Thoughts From Albert Edwards

Tyler Durden's picture

Soc Gen's Albert Edwards, who has never been shy about his cautious stance on equities, has released another report taking his cautionary posture to the next degree. This ties in perfectly with earlier observations by David Rosenberg which unmask the market for the jittery, volatile, headline-driven knee-jerk automaton it has become. Also, Edwards provides a response to readers who are confused by the strategist's endorsement of Richard Koo's mantra of fiscal stimulus as pertains to both Japan and the US. Somewhat tying it all together is the argument that the euro has yet to experience a 25% drop from current levels. That expectation makes the Morgan Stanley euro target of $1.25 seem timid by comparison. Yet in a world of competitive devaluation, as Albert Edwards points out, "it is the nation that devalues last which suffers the deepest deflation." We are confident that Ben Bernanke is all too aware of this mantra.

First, Edwards focuses on leading indicators and what "leading" implications their recent top may have for markets.

In a post-bubble Ice Age world, equity investors have to watch the cycle far more closely than before. One of the key lessons from Japan was that prior to their bubble bursting, equity valuations were dominated by movements in bond yields and hence there was only a very loose relationship between equities and the economic cycle.

But after the bubble burst and as The Ice Age unfolded, the close positive correlation between bond and equity yields broke down as equities suffered secular de-rating - driven by 1) the unwinding of unrealistic market-wide long-term earnings expectations in a low inflation world, and 2) a rise in the cyclical risk premium, as Japan?s own version of The Great Moderation gave way to highly volatile economic cycles.

Japan enjoyed some impressive 50% equity market rallies during their lost decade, driven by strong policy induced cyclical recovery. The secret was to exit as the cycle started to top out as this preceded the equity market dropping to new lows.

Early last year the safe re-entry back into risk assets was signalled by a clear upturn in leading indicators. So too now should investors be concerned that the leading indicators are topping out. The recovery in the leading indicator for China seemed to precede that of the composite for the OECD and similarly China has now topped out ahead of the OECD composite (see chart below). Indeed, other emerging economies such as India (below) and Brazil are also seeing clear warning flags of cyclical caution.

So are leading indicators to the leading indicators the key catalyst to follow in this market?

In a post-bubble world it is far more important for equity investors to follow the cyclical ebb and flow of the economic cycle. We know from the Japanese experience that the post-bubble equity market synchronizes extremely closely with the economic cycle. But, while in a post bubble world massive cyclical gains can still be made in a structural bear market, how does an investor know when it is time to get out of equities?

Certainly my former colleague, James Montier [whose latest, quite pessimistic piece we posted previously], derided the notion of investing on the basis of forecasts as they inevitably proved so inaccurate. It would not be too unfair to say that market and economic forecasters tend to hug the consensus and typically lag events. That is especially true at cyclical turning points. That is why it is useful to monitor proprietary leading indicators. These are especially useful in predicting economic turning points and allow the investor the opportunity to pile into or withdraw from cyclical risk assets.

We monitor a variety of such indicators and until recently they have all been giving an unambiguous green light to participate in risk assets. That has now changed. We noted on the cover the OECD leading indicators for China and other emerging markets have now topped out. But also in the US, some leading indicators have started to dive quite sharply, albeit from very elevated levels (see chart above). In Japan too, we note a topping out action (see below). Recent hard data in Japan such as the closely watched Tertiary (non-manufacturing) activity index has been surprisingly weak, suggesting their anemic recovery is already stalling.

Some more bullish commentators, while accepting that leading indicators are topping out, point to the extreme strength of the recent peak as suggestive of still more positive growth surprises in the pipeline. I think this is wrong. I was always taught that it was turning points that were accurate and hence should be watched closely, and not the magnitude of any directional movement to either the up- or downside.

Going back to macro opinions, and away from indicators, Edwards is extremely pessimistic on the overall economy: when the stimulus effects expire, the double dip will come.

No wonder small and medium-sized companies in the US are still locked in the grip of a massive credit crunch (see NFIB survey -? link). No wonder the US economy is nowhere near as strong as large-cap surveys, such as the ISM, suggest. And there should be no wonder if as soon as the massive fiscal and monetary stimulus wears off, the global economy lapses back into recession.

On to another topic du jour, the euro, A.E. anticipates something close to a 25% correction in the EURUSD pair. And yes, competitive devaluation of currencies will be the primary driver behind most macro risk relationships in the next year.

A word on the euro: we noted last week that the one-size-fits-all interest rate regime had led to a disabling loss of bilateral competitiveness for the so-called PIGS (Portugal, Ireland, Greece and Spain), within the eurozone due to rapid inflation -this in very large part through no fault of their own. Not only are the PIGS? real exchange rates uncompetitive within the currency zone but, on top of that handicap, the entire eurozone is suffering from an excessively strong euro exchange (see chart below).

It could be reasonably argued that the eurozone authorities should welcome a large decline in the euro. With growth in the eurozone looking particularly anemic, these are desperate times. Looking at the chart above, a dollar/euro exchange rate some 25% lower, nearer parity, seems far more appropriate. The end game for The Ice Age was always competitive devaluation and the US and UK have embraced this strategy to revive growth and export their own domestically generated deflationary impulses. Eurozone core CPI inflation currently is a dangerously low 1%. Albeit not quite as desperate a situation as Spain or Japan, this surely is too close to outright deflation for comfort (see chart below).

After all didn?t Ben Bernanke in his famous November 2002 ?helicopter money? speech highlight that “it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34” (Deflation: Making Sure "It" Doesn't Happen Here -? link). In the Ice Age, it is the nation that devalues last which suffers the deepest deflation.

The following berating by Edwards of Europe's worthless political powers is worth its weight in Tungsten. Which once again brings the great debate to the fore - just who is it that is in charge of the developed world: politicians or bankers. Don't answer - it's rhetorical.

Eurozone politicians should stop bleating that the euro is too strong and blaming the deflation-leaning ECB for eurozone stagnation. The politicians should take matters into their own hands and instruct the ECB to intervene to drive the euro lower. In almost all developed industrialized economies, the politicians and not the central bankers decide foreign exchange intervention. And that is also the case in the eurozone, where politicians can direct the ECB to intervene ?after consulting? with it (n.b. consulting does not mean agreeing, see article 219, para 2 of the Lisbon Treaty - link see p101).

In this context a recent paper by Olivier Blanchard, the IMF chief economist, comes at a particularly interesting time. His suggestion that policymakers should be targeting 4% inflation rather than 2% is controversial but spot on in my opinion - link. For with inflation rates now running at such low levels, the risk is that a further ?shock? will tip the global economy into outright deflation. There is nothing sacrosanct about current targets. New Zealand, for example, the market leader in inflation targeting, raised their target from 0%-2% to 0%-3% back at the end of 1996 - link. But the problem for the eurozone, unlike the UK, is that the inflation target is set by a deflation leaning central bank rather than the politicians.

And as for the follow up on Edward's views on Greece as relates to a Richard Koo-endorsed policy action, A.E. notes:

Finally, a quick work on Japan. I had quite a large number of responses to the Richard Koo article I posted about the need to continue to fiscally stimulate throughout the private sector?s de-leveraging process. Many readers rightly commented that the alternative to a relapse into recession is ending up with a wholly untenable Japanese-style public debt situation.

My colleague Dylan Grice'?s view on this is interesting. He believes that Japan?s private sector de-leveraging process was concentrated in the 1990?s. But over the last decade the semi-deflationary, low-growth environment is very much down to the rapid deterioration in the demographic situation. Hence when we contrast the terrible GDP growth Japan has suffered over the last decade (see left hand panel below) with the situation per head (right hand panel below), it is clear that the Japanese economy has in fact been performing perfectly well. Its outsized public sector debt/GDP ratio may be a consequence of poor demographics. In contrast, the US demographic outlook shows a continued expansion of the working age population through this century (Europe is similar, but not as bad, as Japan). So maybe Koo?'s prescription may not result in the US hurtling off into a Japanese-style debt debacle, maybe!

Some additional perspectives on a Japanese comparison, courtesy of David Rosenberg's early AM note:

To be sure, it does look as though the U.S. economy has moved into an expansion phase, but like the markets, it is volatility around the downward trend. This time last year we are seeing -6.4% GDP growth and then by the fourth quarter of 2009 we are at +5.7%. What a swing. It does remind me of Japan, which has experienced no fewer than 12 quarters of 5%+ GDP growth since its bubble burst in 1990 and one-third of these occurred in the initial years after the crisis began. But there have been twice as many quarters with negative growth. Therefore, volatility is the only certainty in the economy following a credit collapse — and the markets as well.

We recall that the Nikkei enjoyed 230,000 rally points since 1990 and the market is still down 70% from the peak at that time. It’s no different for the U.S.A. following the prior credit collapse in the 1930s — the decade saw 20 quarters of 5%+ sequential GDP growth! That’s a depression? Of course it was because there were 13 quarters of contractions mingled into those intermittent positive spasms. Real GDP did a bungee jump of 11% in 1934 and yet if memory serves me correctly, the level of economic activity was basically no higher in 1939 than it was in 1929; and because it was deflation and not inflation that predominated in that period (even with the New Deal!) nominal GDP finished the decade with a 13% loss.

It was not until the first quarter of 1941 — with the help of the war effort — that the prior 1929 Q3 peak in nominal economic activity was taken out (despite seven years of massive FDR stimulus and the odd extremely whippy positive GDP quarter). Moreover, the next secular bull market in equities did not begin until 1954 — 25 years after the prior peak. So the message here is to focus on the forest, not the trees … and to look at an inventory-led 5.7% growth rate in Q4 in the context of wiggles around what is still a fundamental downtrend.

At the end of the day, the focus is precisely on the competitive FX devaluation in a fiat world. Recent frequent overtures by the Swiss National Bank indicate just how seriously this issue is starting to resound. Japan has been posturing as well (yet after 20 years of more of the same, nobody really cares) about incremental monetary policy to break deflation's back. Europe will soon be in the same boat as the US, and with China pegged to the dollar, and very likely to seek a devaluation instead of a currency inflation policy, the dollar will once again be alone as currency flows have no alternatives. Which means that the Fed will have to come up with something very creative in its quest to break the dollar's back (or else kiss Obama's export-led recovery goodbye). We are fairly confident that something will become very evident over the next 6 weeks, with the catalyst being the end of MBS QE, which as we pointed out yesterday is already 96% completed.

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Mr Lennon Hendrix's picture

Comparing one dead duck to another.  The oligarchs think both will make for a lovely dinner, moi! -as in "Geeves, pull the care around.  yes.  Karen, I just love this champaigne.  'moi'."

Euro to spin at $1.33-$1.37 until early April.  DXY to spin at 80-82 until early April as well.

Going Down's picture


"the focus is precisely on the competitive FX devaluation in a fiat world."


The race to the bottom where all winners are losers.


Fritz's picture

Its just a giant game of currency whack-a-mole.

When I see currency-trade product advertising (targeting retail investors) on TV I want to just puke. 

Ripped Chunk's picture

"Competitive Devaluation"

That will be the game now.


Assetman's picture


Anonymous's picture

now, _that's_ devaluation!

rubearish10's picture

So, what you do is deploy a 25% Currency Bond allocation to a USD based portfolio, with 25% for Precious metals, commodity stocks (dry powder) and agra funds. With the other 50%, you deploy a major leveraged short equity position with along with a mix of long dated treasury puts, TBT, TBF. Anything left over you pu some moiney in telecom and utility (defensive equity plays), a defensive hedge fund allocation, some US income funds. Then go play golf every day.


Oh, the other thing you do is play the USD long side as conditions develop via outright FX. Bingo!

dark pools of soros's picture

sounds great but any majored leveraged play will surely get blown up by the house tilting the wheel at their rigged casino


anything played that heavy needs you to sit in the country club hot spot while gaming the market

scriabinop23's picture

Albert Edwards has been so wrong about his calls lately that a monkey playing with darts might have better luck.

His ideas are certainly entertaining though.






B9K9's picture

As Napoleon continued to push eastward during the 1812 Russian campaign, the population of Moscow skyrocketed. Yet when he finally entered Moscow, the entire city was empty except for whores, criminals & lunatics.

The moral of the story? As the fire ring inches ever forward, people will continue to flock to areas of perceived safety before it too is abandoned. First it was a flight from corporates to sovereigns; now weaker sovereigns are falling as each successive firewall is breached.

Some day, perhaps soon, the $USD will be the last instrument standing before a final, mad dash is made into whatever asset class(es) promises to preserve any remaining value.

faustian bargain's picture

I like the Napoleon analogy. I'm imagining the USD as Napoleon's army marching thru Russia.


dark pools of soros's picture

nah its more like the CDS market as the Blitzkrieg 

Anonymous's picture

I agree. The US has had decades of upside by being the reserve currency. Soon we'll see the downside of being the worlds reserve currency. A warehouse of imagined value as others race to the bottom.

Ned Zeppelin's picture

King Dollar - don't bet against it.  But the appearance of invincibility is relative, not absolute.  The only real threat to the dollar is the deficit. If it cannot be funded via debt, it will be funded via the printing press, debasing the currency.

faustian bargain's picture

No, the real threat to the dollar is the day the people realize they've been had. It will be impossible to put that genie back in the bottle.

WaterWings's picture

Thank deity for the Rocky Mountains. Nothing but gun-loving food hoarders and their fat, TV-addled extended family. Wait for the huge heathen die-off once the SHTF. Those attempting to reach this high desert paradise will be wishing they had bigger gas tanks and more sunscreen.  

pslater's picture

Completly correct.  When there's nothing but financial ashes, personally held gold will still be worth somthing.

Gordon_Gekko's picture

You were on the right track but didn't get to the final destination - the final mad dash after the USD will be into PHYSICAL Gold.

Anonymous's picture

How about the gang-sponsored nice "correlation" between SPY and the dollar? If the dollar depreciates the SPY goes higher twice more strongly... If the dollar appreciates the SPY goes up only slightly!!!

Anonymous's picture

The ECRI leading indicator was captured by actions taken during the bail out/stimulus period. It rose from -30 to +30 very quickly.

Those two actions did not in fact do anything but paper over the problems. They created an illusion which the leading indicators reflected.

The leading indicators are not reflecting reality, they are reflecting popular illusions.

Should investors should base their strategy on the reflection of popular illusions?

hedgeless_horseman's picture

Should investors base their strategy on the reflection of popular illusions?


Barack the popular illusionist says, "Yes!" And boy was he right.  The miracle of prestidigiflation!


dark pools of soros's picture

well as fiat is an illusion and that is the current game.. i'd say yes until its not!

Gunther's picture

If all paper-currencies are going to be devalued, over time nobody is going to save any more. Without savings there is no real money to invest and the economy will not grow. That sounds like stagnation, in terms of devalued money stagflation.
Moreover, monetary policy can not cure the mal-investment that happened before. Mc Mansions in the middle of nowhere or unused internet capacity are not worth a lot even if money is easily available. The wealth put in mal-investments is gone, it takes time to realize that.

Devaluation of currency looks like bullish fundamentals for the precious metals. They simply sit around while their currency denominator decays.

Anonymous's picture

You got it! Metal is the only thing left that is real in the age of money printers. And, it's going to get worse as there must be more money printing to get the US out of debt insolvency because of baby-boomer entitlement programs.

Global currency devaluation is not a "if" it is a "when"...and "when" is coming real soon.

Anonymous's picture

Metal's good as long as people think it is. What can I use metal for to survive? You cant easily expand food supply or water as well.

faustian bargain's picture

golly, i dunno, maybe you could use the metal as currency.

WaterWings's picture

Not to be crude, but many will use spouses and daughters as currency when it gets down to it.

dark pools of soros's picture

and slaves as well... and i agree - water would be the new oil AND gold  -  there's just too many god damned people compared to when gold was scarce and fresh water was easily grabbed 

Anonymous's picture

The time to short the Dollar and go long the EUR will be marked when Peter Schiff declares on CNBC that he is "temporarily" bullish on the US Dollar and thinks it can rally a bit further. THAT'S WHEN YOU SHORT THE DOLLAR!!! Not earlier.

dark pools of soros's picture

i can see that being put into the algos already so TBTB can stay on the golf courses

gringo28's picture

the catalyst for growth and stocks in the US in 1941 was not the war but the implementation fo price controls. It was inflation that was out of control at that point in time.

Anonymous's picture

Cheaper labour per unit of mechanization is running out.

Sooner or later, mechanized production will displace human labour to some equilibrium level.

FX will then have only the AG playground, every weather report traded in haste. What a jerk-off world.

40muleteam borax

RossInvestor's picture

I fail to see what difference the Fed's abandonment of MBS QE will make given Geithner's Christmas Eve pledge of unlimited support to Fannie and Freddie.  The Treasury will just buy the MBS's and sell them as UST's to the Fed.  The monetization game will continue.

Anonymous's picture

Words cannot describe how bored I am with the rantings of Albert Edwards. And David Rosenberg to boot. They have both been spectacularly wrong about the reflation, even as they have been right on the economy. They both have Hugh Hendry disease. They are constantly available, exposed, and of course bullish as hell on sovereign debt as it went from the top into the toilet.

Max smirk. And I say that as someone who is *at least* as bearish as they are.

Why do these people have jobs? I see nothing to recommend them.

dark pools of soros's picture

Why do these people have jobs?


..because they are making money for THEIR people...  do you really think you are a part of that?  of course i am going to tell you the coke on the streets is weak if my boys are now selling meth... I'll mix in some bullshit about how shit used to be and maybe even give you some truth on whats coming up but i aint never telling you the truth about NOW

steve from virginia's picture

The Dollar cannot be devalued because the Saudis will not allow it. They have this power because they have spare capacity - nobody else does except for some floating storage wannabes.

The dollar/oil peg is real and cannot be broken. If a serious dollar depreciation attempt is made, oil prices will rise and the economy will crash, destroying petroleum demand. This would drive oil prices lower then bounce to a recovery level where the peg is reestablished. This oil boom/bust peg reestablishment cycle would take about six months ... a period of massive business bankruptcies and millions more unemployed.

The euro is finished. It was created to allow the Eurozone to buy oil without first buying dollars. Now, the European are going to have to buy (ever harder) dollars anyway ... there is no further use for the euro. A diving euro will price fuel much higher in Europe than in America. How non- competitive can you get?

The Fed is irrelevant. US monetary policy is now made in Riyadh. The FOMC raised the discount rate in an effort to acknowledge facts on the ground. The dollar is now a hard currency.

The real game is between Saudia and China ... can Saudia get all of China's dollar reserves?

You betcha! Just watch. Saudia has oil, what does China have? Poisoned dog food! Can the US outmaneuver the dollar/oil peg? Not a chance!

Welcome to 1931. I hope you enjoyed it the last time. I read somewhere that half the banks in the US went out of business. The debacle ran on until all countries went 'off' gold. Our current debacle will go on until we all go 'off' oil.

Sorry auto lovers, there is no other way.

PS, close all your short- dollar positions if you haven't already.

Anonymous's picture

Floating storage is de minimis in the context of global oil flows.

What the Saudis have IMHO been doing is using financial oil leasing


to essentially sell oil in the ground forward via the BFOE market and then buying it back - to help keep the oil price bounded within a suitable range. See also



They, and other producers, have also had almost free money from ETFs to help support the price, in a not dissimilar fashion to the way the International Tin Council used to support the tin price pre 1985.

Hamanaka manipulated the copper market similarly - by borrowing money and lending copper - for five years before David Threlkeld blew the whistle on him, and then for another five years after that.

BS Inc.'s picture

The dollar/oil peg is real and cannot be broken. If a serious dollar depreciation attempt is made, oil prices will rise and the economy will crash, destroying petroleum demand. This would drive oil prices lower then bounce to a recovery level where the peg is reestablished. This oil boom/bust peg reestablishment cycle would take about six months ... a period of massive business bankruptcies and millions more unemployed.

Yep, I think this is the right perspective to have on it.

Miles Kendig's picture

Steve, are you trying to tell me that the value of the dollar US on a trade weighted basis is up over the past decade?

Anonymous's picture

That is right.

To keep oil below $100, the USD will need to strengthen (to compensate for output declining at a rate slightly faster than demand destruction).

So, to keep the Dollar strong, asset prices have to move back in time. But how far? 1980 level prices are baked in the cake in my view (at least in real terms). but how far back do we go? When did the bubble really begin? 1970? 1950? 1913?

Strong Dollar = rampant "asset" destruction and economic collapse. It sounds cruel, but its the only way to keep oil below $100.

Anonymous's picture

Agree on fed s erectile dysfunction, don t know about the EUR, but those Tsys sure look H&Sy here too… Steve, People of China vs the House of Saud already decided? game, set and match now is it?

WaterWings's picture

Unless Putin or Jintao's handlers back Iran in a hot war - how else is WWIII going to fire up? Well, there's always the backdoor biological nemesis.

dark pools of soros's picture

China could invade Saudi -- they can make up some false flag shit too with the eager help of the North K

Anonymous's picture

Today's action in S.E.C. v. BAC in response to Judge Rakoff's request that Cuomo turn over deposition transcripts to look for testimony at odds with proposed settlement agreement (S.E.C. had told Rakoff "I don't think we have any doubt" that the record was complete):

Letter from BAC to Rakoff: "the Bank respectfully objects to the Court seeking, or receiving (particularly ex parte), extrajudicial material from any third party, including specifically the Office of the New York Attorney General ('NYAG')."

Letter from NYAG to Rakoff: "In reponse to this request, enclosed please find:

"Excerpts from the sworn deposition of Timothy J. Mayopoulos, taken on August 25, 2009, as well as the entirety of the sworn testimony taken on October 30, 2009."

NYAG also enclosed excerpts from 4 other transcripts.

Rakoff stated on Wed. that he'd rule by Mon. on the proposed settlement given the 3/1/10 trial date.

Anonymous's picture

Everytime I hear "we are studying the charts" I run away.

How about loading the car and getting out there?
When I first moved to the US I bought an old $500 Toyota and I drove 23,000 miles all over the midwest.

I studied too, and asked a lot of people. Ten years later I knew and "felt" more about the US culture/economics than most of the population.

Back in Greece in 1993 the American guy was showing us graphs - the Greek guy told us during the break "I met with the minister yesterday at that coffee shop - maybe you should buy sugar".
Sugar went up 30% in less than a year.

You can't get a business feel with a computer.

faustian bargain's picture

Stay Thirsty, My Friends.