When Currencies Fail: A Glimpse Into The Future of The U.S. Dollar (#GotBitcoin?)
A Primer On The Dollar Crisis In Lebanon. When Currencies Fail: A Glimpse Into The Future of The U.S. Dollar (#GotBitcoin?)
A massive shortage of dollars is instigating economic chaos, including a more than 50% loss of value in the Lebanese pound and what looks like an enormous local premium for bitcoins. Presented in podcast and full-transcript formats.
The catalyst? Not coronavirus but a massive dollar shortage destroying an economy that relies on inflows of U.S. dollars to function.
In this episode, NLW breaks down how Lebanon models what it looks like for a currency to fail, and why this likely isn’t the last emerging market currency to experience a similar crisis in the months to come.
Welcome back to The Breakdown, an everyday analysis, breaking down the most important stories in Bitcoin, crypto and beyond with your host NLW. The breakdown is distributed by CoinDesk.
NLW: Welcome back to The Breakdown. It is Wednesday, April 29th and today we are going to be talking about Lebanon, specifically the currency crisis overlapping a political crisis overlapping a larger economic crisis that is engulfing Lebanon and I think has relevance for how we understand the dollar in the world, the dollar’s role in the world and the fallout from COVID-19.
I wanted to bring this episode to you because I noticed last week Lebanon start to emerge in the crypto sphere and there were two contexts:
The first was Dan Tapiero. He picked up on a piece by newsBTC noticing that Bitcoin seemed to be trading at fifteen thousand dollars in lebanon via localbitcoins.com which is a peer to peer platform for trading Bitcoin between people. He said the classic emerging market funding crisis was made worse by deflationary dollar peg that is breaking.
Study this case as it will be modeled for other weak emerging markets. It will be a key part of the macro story behind the upcoming Bitcoin price rally.
NewsBTC… They titled their article Bitcoin trades at 15 K in Lebanon amidst economic turmoil showing its real potential. That was part one of how this showed up on the Bitcoin radar. And of course you see Bitcoin trading at a seemingly 100% premium against what we were seeing it at. It’s going to cause notice.
The second context that Lebanon has had within the Bitcoin sphere, the Bitcoin Twittersphere, is images and videos of riots in Lebanon… Where protesters are smashing banks and setting fire to banks over the last two days. And that is happening, but it has a specific context and I think it’s incredibly important to dig into this because this is not just a single country, this is a country that is representative of I think a number of potential challenges that a variety of huge emerging market contexts are going to face in the coming months and the coming years.
And it deeply implicates the question of the role of the dollar in the world and the role of external currencies. So what I’m going to try to do today is give you a primer on how Lebanon got here, how this crisis happened, what this crisis means, and what the real implications are. Now, a couple caveats. First, I am obviously not a Lebanon expert. It is not my main field.
It is not my main point of view and I have put this primer together humbly by doing my own research of the last six months of Lebanese political and economic turmoil. That said, I do have some context in this region. I first went to the middle East in 2004 to study in Cairo. I went back and forth a number of times, probably a dozen times over the course of the next five years or so.
I thought that I was going to spend my life doing either Middle East conflict resolution or just conflict resolution more broadly and spent time all around the region, including in Lebanon and Syria. Again, this was a long time ago. I was in Lebanon last in 2006 and Syria last in 2006 as we know, those places are very different than they were then, but this is not a complete neophyte perspective. I guess I do have some time booked both in the region and spent looking at the history of the region.
I’m not going to get too deep into history today. I’m really just going to focus on what’s been happening over the last six months and put it in the larger global economic context we have. Here’s the TLDR on this. This is not a story of Bitcoin trading at a premium because people are desperate to get into Bitcoin.
This is a story of a local currency failing and people trying to find any on-ramp to access any US dollars that they can. That’s the real story and that’s the important piece of this conversation. Let’s do a little bit of Lebanon economic basics first. A key thing to note is that this is a country where almost everything consumed is imported.
That’s a really important note because as we’ll see, imports are purchased with dollars and then sold for Lebanese Lira. Even before all of this happened, Lebanon had a huge debt to GDP ratio, one of the worst in the country between 150% to 170% debt to GDP ratio. This is a country that borrows a lot. It has had a dollar peg since 1997 of approximately 1500 Lira to one US Dollar. It has had a dollar peg since 1997 of 1500 Lebanese pounds or Lira to one USD.
An article in the New York times described this rate thusly, they said, “but maintaining that rate required continually bringing new dollars into the country, usually by enticing wealthy investors to make large dollar deposits for high interest rates. A strategy that some economists have compared to a Ponzi scheme.” We’ll get into this more in the banking system more in a minute. But the key part for our purposes is that since 1997 the dollar has been pegged 1500 Lebanese pounds to one US dollar and it’s been maintained through central bank policy.
This is an economy that is 70% dollarized and it has only been sustainable because of diaspora inflows back to the country. So a huge number of Lebanese depositing money into the Lebanese banking system from abroad as well as from inflows from other regions. So Lebanese banks have attracted huge foreign inflows for years and years and years through offering high interest rates and basically that allows the country to pay for imports even though it has such low exports.
So in this way, the banking system is really key to the economy. The deposit base in fact in Lebanon is usually something like 2.5 to three times the size of the economy. However, the banking system is hugely compromised right now. And this is not just a coronavirus thing. In fact, as you’ll see, this story is not particularly a coronavirus issue, although as with everywhere else, the coronavirus shutdowns have exacerbated the situation, so the banking system is compromised. 70% of assets are lent to the state itself, but government bonds are trading 40 to 50 cents on the dollar.
Of those 30% of loans that are to the private sector, 25% of those are non-performing. And what that means when you add everything up from the central bank balance sheet is that half of the assets of banks are impaired. They’re problematic. This could be okay in some short term way if there were still huge inflows from abroad into the banking system, but there haven’t been in the same way because of regional turmoil.
There is the obvious crisis of the war in Syria, which has been ongoing and dragging the entire region down. There is trouble with Iran who basically uses Hezbollah to meddle in Lebanon’s affairs and has for decades. There is a crisis with the relationship with Saudi Arabia, which went really bad in 2017 to say the least and I will point you to more resources to learn about that, but when that relationship went bad, we saw some of the first gasps of dollar outflows in late 2017 1.5% of cash deposits were withdrawn from the Lebanese banking system in fear of what that regional turmoil might do.
So effectively we have a very unstable economy that is largely propped up by a robust banking sector that has been attractive to both foreign Lebanese as well as to the region for years, but as political crisis engulfs the region and compromises that banking system, it makes the system of continued inputs very compromised.
And so this is the context for where we started to see real problems happen last year. The center, underlying problem which metastasizes and metastasizes in this situation is not enough dollars to keep this economy going. As I was mentioning before, if you have a net import economy that uses dollars and your local currency interchangeably, what happens is that all of those purchases of imports happen in dollars, right?
If the U S is sending wheat or anything else to you, it’s going to bill you in dollars, not in Lebanese pounds, but then your local market, your local consumer base, uses those Lebanese pounds to buy that good. The peg keeps that system working, but if the peg starts to break, it can deteriorate incredibly quickly. Keep in mind as well that there is a dollar shortage around the world. This is not a Lebanon unique situation.
The U S dollar has been the strongest and clearest asset, the world’s global reserve currency, not just theoretically, but in a way that is profound for a long time. And so imagine the pressure of trying to get dollars everywhere, but manifested in a specific nation-context like Lebanon. That’s what we’ve been dealing with. So last August the 1500 Lebanese pound to us dollar peg started to break. In September, an economic state of emergency was declared and the government actually used WhatsApp to say that they plan to raise taxes to cover government expenditures.
This sparked protests because there was already a lot of questions around the legitimacy of government and corruption in government. So when the government said that they were going to come seize citizen money through taxes, basically to cover their expenditures, there was a wave of protests. This was exacerbated in October. On October 11th there was a nationwide strike demanding the ability to pay for fuel imports in Lira, in Lebanese pounds rather than dollars. A sign seen on Twitter said, we apologize to the Lebanese people due to the lack of dollars to buy fuel.
“We are closing our petrol station until we can secure this product in Lebanese pounds.” So again, this is the situation we were just describing. Petrol station owners sell their fuel in Lebanese pounds, but have to buy it in US dollars from importers. This also happened to mill owners. People who are bakers who buy imported wheat in US dollars. What happens of course, is that as the peg starts to come undone, that itself creates more demand for dollars, which causes the peg to come further undone. So put yourself in the situation of your average Lebanese person.
You’re seeing these strikes around fuel importers around bakeries who aren’t able to get the dollars they need to buy the imports that allow their businesses to work. You’re an average citizen. You say, well, damn, if there’s dollar shortages, I need to go get my dollars out, which causes a run on the bank.
Banks start to limit withdrawals, which is exactly what happened. Banks started to limit how much could be withdrawn in USD and that creates more demand for dollars. All of a sudden that activity moves to the black markets because if banks won’t allow people to withdraw money or get access to dollars, black markets will, but the black market price is not going to stay the same as that official peg. This keeps going on.
As people start to see the peg fall further, they want to minimize loss. They go from, “I don’t want to lose the value that I would have had at that official peg going on the black market” to “The black markets, the only place I can get those dollars, if it’s 2000 Lebanese pounds to the dollar, now, I want to lock in that loss rather than worry or take the risk of a loss of greater debasement of the value of the Lebanese pound in months to come.
So it’s a very vicious cycle. So, big protests start in October. Prime minister resigns at the end of October. Protests continue through November. Fast forward to February, early March… GDP is down from 55 billion to 44 billion. 220,000 jobs in a country of 5 million are lost between October to February. Food prices are up 58% and key parts of the industry are just totally left shuttered. So this is a quote from an article. Importers of critical goods such as medical supplies, say their requests for dollars have gone almost entirely unmet since February.
Leaving many hospitals dangerously low on everything from heart stents to dialysis equipment on March 7th an extraordinary thing happens for the first time Lebanon defaults on a foreign currency debt payment. This is one thing that was holding Lebanon together is that it had a relatively high standing in foreign markets because it didn’t do things like default on debt payments.
It did in March for the first time and then COVID-19 hits and the economy is locked down since the middle of March, which is just pouring gasoline on an absolute dumpster fire already. So let’s look again at what’s happening in the currency markets as this foreign currency default happens in the beginning of March, the official exchange rate remains at 1500 Lebanese pounds to the dollar, but on the black market, money changers are getting 2,500 pounds to the dollar.
There are a growing wave of people who are extremely worried, right? Think about middle-class Lebanese who are paid in Lebanese pounds, but who owe tuition or mortgages that are denominated in dollars. It’s the story that we hear over and over again in dollar denominated debt. No one can get dollars to bring in goods from abroad. So businesses are shuttering and to make matters worse, and this is how these economic crises play out.
Lebanese banks, which are terrified of bank runs, are continuing to reduce how much people can actually take out of their accounts and they’re doing so with caps, they are setting the exchange rate price lower than what the black market is saying. Then we get to April and things get really bad. The official peg is still at 1500 but it’s gone to 3,500 in black markets. A few weeks into April bank start making some small concession.
They allow small depositors to cash out dollar savings, but at 2,600 pounds, so this is obviously more than the 1500 but way less than the 3,500 pounds that the black market was saying a dollar was worth. The blame game heats up between the prime minister and the central bank governor in a televised speech, the prime minister said the central bank is either incapable, absent, or directly inciting this dramatic depreciation.
There’s clear politicking involved in, like I said at the beginning, there’s so much to Lebanese politics that I can’t get into it now, but it’s worth looking into, but there’s credence for these accusations, at least in the context of regular citizens and protestors because the Lebanese bank has at this time been trying to buy up all the dollars they can from money transfer companies at a rate of 3,625 Lebanese pounds to the dollar.
So in short, the Lebanese bank is trying to buy as many dollars as they can get their hands on at a rate that’s much higher than the exchange rate that they’re allowing Lebanese citizens to withdraw at, which is obviously going to cause incredible foment. There’s no way that people are going to just let that pass, especially when the prime minister is saying that the central bank governor is to blame for this crisis, which brings us to this week and the videos and images you’ve seen on Twitter of banks burning around Lebanon.
Aljazeera called this the night of the Molotov and for the last two nights at least a dozen Lebanese banks have been torched, vandalized as part of this growing frustration. Effectively these protests are now turning violent because the desperation is getting to reach a fever pitch with no end, no clear plan in sight. Even before all this, it was estimated that poverty was around 50% in the country at the beginning of the year.
Now, the social affairs minister of the country is estimating that some 75% of the population require aid. Meanwhile, the economy, what’s left of it is still shut down because of the coronavirus. That’s where we are now. We have a crisis in freefall which has lost at least 50% of its value against the dollar and realistically more since the middle of last year with a rate of descent that is increasing.
We have a political instability where an already compromised and unloved government is blaming the central bank for this machination. We have an economic system that’s based not on economic fundamentals but financial engineering that requires an ever growing influx of foreign investment, foreign currency into the system that once that dries up just shuts down. All told what you have is that complete currency collapse and by extension economic collapse of a nation that has at times been one of the bright lights of a very troubled region.
Let’s return back to the article that got Bitcoin’s attention in the first place. This idea that Bitcoin was trading at 15,000 Lira in Lebanon amidst economic turmoil showing its real potential. The article was based on the sell price on local bitcoins.com of a Bitcoin going for as high as 22,678,227.03 Lebanese pounds per token. If you divide that by the official expressed Lebanese pound to dollar rate, which is 1500 you get this 15,000 number.
That’s where it comes from. It is factoring in or it is assuming that the exchange rate of 1500 is the actual exchange rate. As we’ve discussed, the real exchange rate in Lebanon right now is somewhere between 2,600 which is what the banks are offering people to withdraw there. Lebanese pounds at or 3,600 which is what the central bank is paying for dollars on the open markets and what Lebanese are paying in the black markets.
When you divide this offer of 22 million Lebanese pounds per Bitcoin by those numbers, you get a number that looks pretty much exactly like what Bitcoin was selling for everywhere else. Does this mean that we shouldn’t see Bitcoin as an interesting, relevant asset for this region? Should we dismiss this idea that it is “showing its real potential?” My answer is “absolutely not”, but we have to understand how Bitcoin and other digital assets are functioning in the real world right now.
The story of Lebanon that I’ve just told, which is the very TL;DR version is a story where people don’t have control over their money. Their money is predicated on a banking system that has its own interests, its own machinations, its own incentives that for a while aligned with theirs. But as soon as it didn’t, shut down their ability to actually control their wealth and effectively enabled their wealth to be reduced by a factor of 50% in the course of just a few months.
Imagine that you had been saving in a bank doing what you’re supposed to do, being a good citizen, putting away your money for years and years and years and over six months. It’s cut in half simply by the debasement of the currency. That’s what we saw. What Bitcoin is reflective of and how people are using it in this crisis is trying to escape a local monetary regime that is crumbling.
What the world is doing though, and I think that we have to expect this is going to be the case for some time, is they’re escaping, not into Bitcoin per se, but the dollar. The dollar is the world’s escape valve currency. Even in Lebanon, before this turmoil, the whole system was predicated on being able to move easily into the dollar. The problem is that as the dollar becomes the only asset for the entire world, there’s a shortage of them and it becomes harder and harder to get into the dollar.
Now, the interesting thing is as we watch the total circulating supply of USD based stable coins rise, I think that’s part and parcel of this as well. It is people trying to get dollar exposure and escape from local monetary regimes by accessing the digital currency world. This is not a diminishment of Bitcoin, but we also need to be clear that it’s not some super premium because Lebanese who are desperate are trying to get into this new currency.
Lebanese who are desperate are trying to get to the currency that they’ve always used to actually pay the key debts that they have, which is dollars. We live in a dollar denominated debt world until that is no longer the case, part of Bitcoin’s role is going to be to help people escape out of these local monetary regimes, which are collapsing and get money to where it needs to be into different currencies. Even synthetic ones. I don’t think that’s a knock on Bitcoin. I think it’s in fact an affirmation of its power as an uncontrollable non-sovereign currency.
But we have to speak about what is actually true, not just go for the headline. So hopefully this has been an interesting or enlightening look at what’s going on in Lebanon. As I said, I am not a Lebanese expert. I put this together on the basis of just my own research and reading, but I fear that it is reflective of a lot of places we’re going to see around the world that face this same perfect storm of a bad local monetary regime and currency crisis that ensues, a shortage of dollars that makes it worse and the lack of a fundamental basis for the economy that can solve it.
Anyways, guys, let me know what you thought about this episode. Hit me up @NLW on Twitter and if you liked it, share and subscribe. Let me know because this is a little bit of a departure, although to me, I think this is the type of issue that is sort of the most important for us to really, really understand. If we want to think about how digital currencies and Bitcoin specifically have a role in the world to come. Thanks as always for listening and until tomorrow, be safe and take care of each other. Peace!
Don’t Buy Bitcoin, Says Wealth Exec As Lebanon Chooses BTC Over Fiat
Bitcoin and gold are “too speculative” and it’s better for investors to trust the government to pay them back, claims Peter Mallouk.
Bitcoin (BTC) is not what young investors should buy after the coronavirus crash, says the man who once said that the biggest cryptocurrency faces an “inevitable death spiral.”
Speaking to CNBC on May 21, Peter Mallouk, president and chief investment officer at wealth management firm Creative Planning, claimed that stocks and bonds were better options than Bitcoin and even gold.
Mallouk: “No Need” To Buy Bitcoin Or Gold
“There is no need to go over into the speculative world,” he told the network, arguing that assets such as Bitcoin and gold “see a lot more booms and busts.”
Basically, we define ‘speculative’ as anything that doesn’t produce income and bring it to you as an investor.
Mallouk was speaking as Bitcoin far outperformed stocks, bonds, oil and gold year-to-date. As Cointelegraph reported, the cryptocurrency’s 2020 performance has no comparison, having entirely erased the losses from its crash which also took down traditional markets. Their recovery, however, has been much less certain.
Even Mallouk himself appeared to doubt the appeal of his own advice. While recommending buying bonds, he could not avoid mentioning the amount of blind faith required in the issuer.
“If you’re loaning money to a company or government, that company or government is promising to pay you back,” he continued.
It’s no different from loaning money to your brother — hopefully, your brother’s really economically stable, you loan him money, he’s going to pay you back.
It is precisely this lack of the need to trust that Bitcoin has become the top investment available in terms of its “hardness” as money. Unlike with fiat, companies or bonds, there is no need to worry whether the actions of a small number of people will destroy an investment’s value.
Lebanese Investors Vote For BTC
Lay consumers have once again been voting against fiat investment en masse and in favor of Bitcoin this week. According to a survey of Lebanese residents currently circulating on Twitter, 57.5% of the 6,661 respondents would prefer to receive their salary in Bitcoin.
The sentiment comes as the value of the local currency, the Lebanese pound, continues to freefall. Earlier this month, a dollar peg in place since 1997 vanished, adding to the rout.
At the same time, Gemini co-founder Tyler Winklevoss is sounding the alarm over governments’ gold buying strategies. The Bank of England blocking access to Venezuela’s reserves “may cause some governments to rethink their gold strategy,” he argued on Thursday.
Mallouk meanwhile is convinced that Bitcoin will fail. In December 2018, around the time that BTC/USD hit lows of $3,100, he said that for him, “Bitcoin is dead.”
“It won’t go quietly, but the recent precipitous drop may be the beginning of its inevitable and inexorable death spiral. Or there could be a dead cat bounce,” he wrote in Forbes.
Either way, I see bitcoin as a dead man walking.
According to the current count of such “obituaries” by 99Bitcoins, Bitcoin has now died and come back to life 380 times.
Lebanon’s Central Bank Burns As Protesters Rail Against Fiscal Failures
A spiralling currency crisis in Lebanon sparked widespread protests targeting central banks an increasing embrace of digital assets.
Protesters in Lebanon have set fire to the central bank in Tripoli in a show of anger with the country’s deepening economic crises and stagnant political orthodoxy.
Joyce Karam of United Arab Emirates-based media outlet TheNational reported June 11 that the Lebanese pound (LBP) is trading for more than 5,000 per $1 in spite of the country’s official peg of 1,507 per dollar— a 20% depreciation since April, and over 230% since the peg was respected in January.
However, recent reports also indicate that an increasing number of protestors are embracing Bitcoin (BTC) as a means of bypassing Lebanon’s failing monetary system.
Banks Burn As Unrest Grows
On June 12, Reuters reported that Lebanon’s central bank will begin injecting funds into its currency market in a bid to stem the rapid depreciation that has escalated tensions and local unrest.
The report notes some currency dealers have already responded to the central bank’s move, lowering prices down to roughly 4,500 pounds per dollar. Government officials have also pledged to take action intended to reduce its value by to roughly 3,000 pounds per $1.
However, recent attempts by politicians to quell the country’s deepening economic crisis have been largely unsuccessful, with protestors having erupted into multiple demonstrations targeting banks with rocks and fire in recent months while Lebanese officials racked up record debts.
Bitcoin Grows In Popularity As Currency Plummets
Amid the turmoil, an increasing number of Lebanese citizens are turning to Bitcoin and cryptocurrency, with Nikkei Asian Review reporting that digital assets are “being embraced as an alternative to dollar assets” among the country’s protesters.
However, confusion surrounding the value of Lebanese fiat has led to erratic prices being listed on peer-to-peer Bitcoin marketplace Localbitcoins — with current buy listings ranging from 19 million LBP to 57 million LBP per BTC, while sell offers range from 12.5 million to 40 million.
Bitcoin is increasingly gaining popularity as an alternative store of value in country’s facing violent hyperinflation, with Venezuela long comprising a leading market by volume on Localbitcoins.
Producer Prices Jump Most Since 2018 In Hint of U.S. Inflation
Prices paid to U.S. producers rose in February from a year ago by the most since October 2018, adding to evidence of mounting inflation in the production pipeline as the nation starts to emerge from the pandemic.
The producer price index for final demand advanced 2.8% from February 2020 after a 1.7% year-over-year gain in January, Labor Department figures showed Friday. The median estimate in a Bloomberg survey of economists called for a 2.7% increase. The PPI rose 0.5% from the prior month.
Excluding volatile food and energy components, the so-called core PPI increased 2.5% from a year earlier.
Producers continue to find success passing along higher raw materials and transportation costs to their customers, adding fuel to the debate about whether inflationary pressures at the consumer level will become more durable.
Investors and economists are split on the inflation outlook, with some projecting price pressures will keep building amid stronger demand and government stimulus, while others forecast the build in inflation will be short-lived.
Rising producer prices have the potential of feeding through to the household costs of living. While a report Wednesday showed that the core consumer price index — a key measure of prices paid by U.S. consumers — rose less than expected in February, stimulus spending, income growth and a steady pace of Covid-19 vaccinations suggest inflation will mount.
The overall advance in producer prices was driven by an 1.4% month-over-month increase in the cost of goods, the Labor Department said. Energy and food prices both accelerated from a month earlier.
Final demand services costs edged up just 0.1% from January, led by higher transportation and warehousing prices that included a jump in airfares.
Prices paid for materials and components used in manufacturing climbed 2.6% in February after a 2% gain a month earlier. Those same goods used in construction increased 1.4% last month.
The costs of processed goods for intermediate demand rose 2.7% in February from a month earlier, a broad advance that was the largest since July 2008.
On recent earnings calls, a number of U.S. companies said they’ve been able to pass along rising raw materials and transportation costs as a result of pandemic-battered supply chains to their customers.
* Producer prices excluding food, energy, and trade services — a measure preferred by economists because it strips out the most volatile components — rose 2.2% in February from a year earlier, the biggest gain since May 2019
* Gasoline prices jumped 13.1% in February, accounting for about 40% of the month-over-month gain in the PPI, Labor said
* The cost of services was restrained by weaker margins in apparel retailing.
Housing Industry Calls For U.S. Action on ‘Skyrocketing’ Lumber
Soaring lumber prices and chronic shortages are prompting key U.S. housing industry participants to call on the Biden administration to find remedies that’ll boost wood production.
Thirty-seven organizations are calling for the “immediate attention” of U.S. Department of Commerce Secretary Gina Raimondo to address “skyrocketing” lumber prices and supply constraints they say endanger economic recovery and housing affordability.
“We respectfully request that your office examine the lumber supply chain, identify the causes for high prices and supply constraints, and seek immediate remedies that will increase production,” according to a March 12 letter signed by groups involved in areas of housing including construction, real estate and manufacturing.
The pleas come as higher prices for wood threaten to stifle the number of planned construction projects across North America and push prices for new homes even higher due to rising costs, exacerbating woes faced by new homebuyers in the past year. Soaring prices for wood have lifted the average price of a new single-family home in the U.S. by more than $24,000 since April, according to the National Association of Home Builders.
Lumber prices have nearly tripled while those for boards used in residential construction have jumped more than 250% since last spring, according to the letter.
“Home builders and construction firms that have signed fixed-price contracts are forced to absorb these crippling increases in materials prices and costly delays in deliveries,” the letter said, adding that “there is a significant risk that many of these firms will be forced out of business.”
Costs that can be passed on will make housing less affordable, the letter said, while “other projects will no longer be economically viable, which undercuts the availability of new housing supply and further jeopardizes affordability.”
North American lumber prices are expected to extend gains through this year as homebuilding and renovations cause demand for wood to outstrip production, according to forecasts by Forest Economic Advisors LLC.
“Production is going to have a hard time keeping up with demand growth as the world economy bounces back from Covid-19 in 2021-22,” Paul Jannke, the FEA’s principal of lumber, said Thursday during a conference hosted by the industry research group. That’ll keep the average lumber price this year above levels seen in 2020, he said.
The surge in lumber demand initially took the industry by surprise in mid-2020 as the pandemic fueled a flurry of home renovations while homebuilding soared. Lumber futures rallied to record highs above $1,000 per 1,000 board feet in February, driven in part by low supplies of wood products. The contract, which averaged around $456 last year, was at $972 on Thursday.
Renovation activity is expected to stay “extremely strong,” according to Brendan Lowney, principal of macroeconomics at FEA.
“We’ll come off a boil, but we expect that market to still run hotter than it has in the last 10 years.”
North America’s lumber deficit will mean that more wood product needs to be imported from Central Europe, where a beetle infestation has killed trees and led to increased logging, according to Jannke. Unlike the U.S., European lumber production is expected to exceed consumption, allowing Europe to boost its exports, he said.
U.S. lumber imports will need to increase by roughly 14% to 15% this year, Jannke said. China has also increased its appetite for lumber, and FEA forecasts the Asian nation will need to boost imports by around 14%.
“There’s not going to be enough fiber to supply global demand for saw timber over the next decade,” Jannke said, adding that only the southern U.S. and Russia have significant amounts of excess timber.
“We find it hard to see where this fiber’s going to come from.”
Investors Dust Off Trade That Protects Returns From Rising Rates
Central-bank bond buying has made it relatively painless for credit investors to switch to short-maturity debt to avoid risks from rising interest rates.
Money managers at Amundi SA and Axa Investment Managers, which have combined holdings of $3 trillion, have been turning to a trade known as “curve positioning,” in which they switch out of long-dated debt and into similar notes with a shorter duration.
“We have quite good visibility on corporate fundamentals. The main uncertainty is in rates,” said Gregoire Pesques, head of the global credit team at Amundi, which oversees 1.7 trillion euros ($2 trillion). His team has been making the switch over the past two months, but says it “makes even more sense now.”
The trade is possible because the European Central Bank, which said it would “significantly” boost the pace of its emergency bond-buying program, has flattened corporate spread curves with its debt purchases. The spread between five- and 10-year euro debt is currently about 16 basis points, down from 28 basis points at the start of last year.
Nicolas Trindade, a portfolio manager at Axa Investment Managers, which oversees 858 billion euros, says the trade has increased the defensiveness of his portfolio without significantly denting returns.
Once they’ve shortened maturities, investors can boost spreads by taking different types of risk, such as buying subordinated notes or those on the cusp of junk. Though this potentially leaves them open to a market selloff or greater default risk, it has paid off this year, with high-yield notes posting returns of 1.16%, compared to minus 0.68% for their investment-grade peers.
U.S. Core CPI Rises Less Than Estimates, Easing Inflation Alarms
A key measure of U.S. consumer prices rose less than expected in February as costs of used vehicles, clothing and transportation services declined from a month earlier, suggesting broader inflationary pressures remain tame.
The core consumer price index, which excludes volatile food and energy costs, increased 0.1% from a month earlier and 1.3% from the prior year. The overall CPI rose 0.4% from the prior month and 1.7% from a year earlier, a Labor Department report showed Wednesday.
The median estimate in a Bloomberg survey of economists for the month-on-month change in the CPI was for a 0.4% gain. The core measure was projected to rise 0.2%.
Core inflation “is being buffeted around in an erratic fashion by the pandemic, causing strange movements in prices for a number of categories in any given month,” Stephen Stanley, chief economist at Amherst Pierpont Securities LLC, said in a note.
“One of the first signs of fundamentals returning will likely be when airlines and hotels start to nudge up their prices in the face of improving demand, an event that is probably at least a few months away.”
Stocks advanced in early trading, the dollar fell and the yield on the U.S. 10-year Treasury note rose slightly.
Yields on U.S. Treasuries have surged recently on inflation bets, but Federal Reserve officials have brushed off the concerns and expect any pickup to be transitory.
Investors and economists are split on the inflation outlook, with some predicting a wave of rising prices driven by stronger demand and pandemic stimulus, while others say the forces that have contained price pressures for years — from technology to demographics — are still in place.
Despite the softer-than-expected figures, inflation is poised to accelerate in the months ahead — driven by pandemic stimulus, income growth and a vaccination campaign that’s helping businesses to reopen.
Starting with the March data, the so-called “base effect” will push up the headline rate, because sharp declines in prices at the start of the pandemic will influence the year-on-year calculations. That means even fairly small price increases during the month will likely cause the annual measure to jump above 2%.
Some pockets of the economy are already showing signs of bubbling inflationary pressures. In January, a measure of producer prices surged by the most in records dating back to 2009. The Institute for Supply Management’s factory measure of prices paid for materials rose to the highest since 2008 last month.
Energy costs played a key role in boosting the overall CPI. Gasoline prices rose 6.4% in the month, and the index for electricity climbed 0.7%, which was the most in five months. Freezing temperatures across much of the U.S. — most notably in Texas — drove up demand for heat.
The government’s measure of shelter costs rose 0.2% from a month earlier, the most since July. Owners’ equivalent rent registered its largest gain in more than a year, reflecting higher housing prices.
The Biden administration’s $1.9 trillion stimulus bill will add to the more than $1 trillion in excess savings that American households racked up during the pandemic. It’s unclear how much of that money they’ll spend in the coming months on things they couldn’t do during the health crisis, like restaurant dining or travel.
The CPI report showed prices of goods, excluding food and energy, declined 0.2% in February from a month earlier, the first decrease since May. Core goods costs climbed 1.3% from a year ago.
Apparel and medical care commodities costs both dropped 0.7%, while prices of used vehicles fell 0.9% for a third month. Prescription drug prices fell by the most since July 2018.
Services prices minus energy rose 0.2%, the first increase in three months, reflecting higher shelter costs and medical care services. They were also up 1.3% from a year earlier.
* Food prices rose 0.2% from a month earlier and are up 3.6% from February 2020
* Energy costs jumped 3.9% from January, the most since June
* A separate report Wednesday showed inflation-adjusted hourly earnings increased 3.4% from February last year.
How Stimulus Could Backfire Against Low-Wage Workers
Don’t trust assurances that the Fed won’t panic over bursts of inflation and cut short the recovery before it starts to help the households who need it most.
President Joe Biden’s $1.9 trillion economic relief plan is on the verge of becoming law. With so much uncertainty about the likely course of output, employment and prices, its effect on the economy is unusually hard to predict. But it’s a fact that Congress is providing much more stimulus than any reasonable dollar estimate of the economy’s underlying need.
That’s provoked a debate among policymakers and economists about the risk of sustained, runaway inflation, with warnings of the dangers posed by widening deficits countered by assurances that the government possesses the tools to keep prices and wages under control.
But there’s a third possibility, a gloomy scenario that deserves more attention than it’s received: the likelihood that this experiment in spending so much more than the economy needs will end in a mild recession caused by a backlash at the Federal Reserve. That outcome could deny low-wage workers the benefits of a longer economic expansion.
Even without the additional $1.9 trillion, the economy in 2021 was poised for a strong increase in consumer demand for goods and services. Congress passed a $900 billion stimulus in December that will support the economy this year.
(That law by itself is larger than the stimulus Congress passed in the waning days of the 2009 recession provoked by the global financial crisis.) Households are sitting on $1.8 trillion of excess savings, and will spend a large share of that over the course of this year. The pandemic is fading, states are reopening, and households are surely going to go a little wild this summer and fall.
Add Biden’s $1.9 trillion — much of which will go into consumers’ pockets — and demand will surge.
This additional stimulus is certain to push the economy above its sustainable level of output. By my calculations, without the president’s plan, the pandemic would reduce economic output by $330 billion over the remainder of 2021. So even if the stimulus only generates 50 cents of economic activity for every dollar of government spending, it would still fill that hole nearly three times over.
The combination of this extraordinary amount of fiscal support and unusual macroeconomic environment is likely to cause three things to happen.
First, surging demand in the face of lagging supply will put upward pressure on the underlying pace of consumer price increases. Markets currently expect inflation to average 2.4% over the next five years, up from around 1.5% prior to the pandemic and 1.6% prior to the presidential election in November.
If investors are right, then inflation will hit the sweet spot — higher than the Fed’s 2% target, but not so much higher as to cause concern. Trend inflation of 2.5%–3% would be a policy victory.
Second, there will be a month here and a month there where inflation will deviate from its underlying trend, with aberrant, transitory monthly price level increases of, say, 4% or 5%.
Periodic bursts of eye-popping price growth may not be sustained, or even problematic, but the second or third time one occurs, it will receive a lot of attention. Inflation will be front-page news. Republican members of the Senate and House of Representatives will demand hearings and grill policymakers. It will be the talk of Wall Street.
Third, the president’s stimulus law will fuel concern about bubbles in financial markets. Personal income will soar once the new stimulus is enacted. A lot of that money will be saved. And much of those savings will go into assets like stocks and real estate, pushing up their prices. Indeed, due to the extraordinary fiscal support already offered to households by Congress, the past year has seen months with record rates of personal income growth and savings.
These three factors — an above-target underlying rate of inflation, periodic bursts of rapid price growth and concern about bubbles — add up to a bad situation for the Fed, which would be put on the defensive about its blasé attitude toward overheating. Fed governors could wake up one day feeling that they had fallen behind the curve.
Knowing that monetary policy affects the economy with a lag — and being able to declare victory in having allowed inflation to rise above its target rate — the Fed could attempt to slow the expansion without ending it. But the Fed can’t manage the economy with precision. In this scenario, the Fed would probably cause a mild recession.
This could leave low-wage workers out of the recovery. A rising tide does lift all boats, but not at the same pace or at the same time.
Take the expansion following the recession that ended in 2009. My research with economist Jay C. Shambaugh shows that wages for the bottom 20% of workers were much higher when the pandemic began in 2020 than when the financial crisis struck in 2007.
But we found that wages for those workers didn’t begin to rise until 2014. If that expansion had ended in 2014, after five years, then most workers would have been in worse shape following the expansion than when the recession began in 2007.
This highlights the importance of keeping expansions going as long as possible. A hot economy with tight labor markets is the best jobs and wages policy. But the likelihood of a backlash to a too-hot economy and frothy financial markets puts the longevity of the current expansion at risk, along with its benefits for workers near the bottom of the wage scale.
An even worse outcome is possible, and has received a lot of attention. Demand could surge even more than I expect. The generosity of unemployment benefits could keep many workers on the sidelines, holding back the ability of economic supply to meet demand.
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