What’s Brown and Sounds Like A Bell?

In a Monty Python sketch, Python player Eric Idle asks the question: “What’s brown and sounds like a bell”? The answer: “Dung!” Although we do not wish to be so crass, we cannot think of a more fitting description on the so-called decoupling of the U.S. economy from those of our trading partners.

Today, the economy is more global than ever. If the economy is global, how in the world can ANY economy decouple, never mind the world’s biggest economy? I admit that the relationship between the U.S. economy may be more symbiotic (rather than the U.S. being overly dominant as in the past), but as in any symbiotic relationship in nature, when one partner becomes ill, the other(s) feel the effects as well. When that one party is considered the “host”, the effects will be felt among those who depend on the host for their survival.

The U.S. economy remains dominant. It is the world’s market place. If China was no longer able to produce goods affordably, it is likely that another country or countries would be eager and able to take its place. However, take away the U.S. economy with its benchmark consumer spending and the gears of the global economy grind more slowly.

This is what we are now experiencing. U.S. consumer spending has slowed and may continue to slow as long as the housing market is dislocated. Most major foreign economies are now experiencing varying degrees of slowing. This has burst the anti-dollar bubble. The dollar has strengthened sharply versus most foreign currencies. This has, in turn, burst the oil bubble. As we have said previously, strengthen the dollar and oil prices will fall. The threat of increased drilling and alternative energy plans has helped to push oil prices lower as well.

Although I believe that oil prices had been too high given current and future demand versus current and future supply (once other sources of oil, which would be come economically viable with oil at elevated levels, were considered), oil may not fall back to pre-bubble levels. Just as those who predicted ever-rising oil prices have been proven incorrect (for now), calling for oil to fall to $60, $70 or $80 may be premature. Remember, bubbles work in both directions. Look for oil to remain range traded at or near current levels until geo-political events dictate otherwise. Also, look for the dollar to remain range traded in the $1.40 to $1.50 ranged, until economic forces dictate otherwise.

Why is fixed income publication discussing the foreign currency exchange markets? Because I also deal in international bonds denominated in foreign currencies. Many retail investors speculate on the value of foreign currencies versus the U.S. dollar by purchasing bonds denominated in foreign currencies. Make no mistake, when one purchases a bond denominated in foreign currencies, one is speculating. This is true even of AAA-rated sovereign debt. Why is one speculating? Although investors will receive timely interest payments and return of their principal at maturity, those payments will be in the particular currencies in which the bonds are denominated. One may get par at maturity, but what it is worth in U.S. dollars may surprise some investors. If the dollar strengthens, one could lose money by investing in foreign-denominated bonds, even when receiving par at maturity.

This has happened to some investors in recent weeks. We and our colleagues have received several calls asking why and how clients lost money on foreign-denominated bonds when they received par at maturity. The answer was that the U.S. dollar has strengthened. Investors must consider currency risk when investing in foreign denominated bonds.


The GSE situation has settled down. The Wall Street Journal's editiorial page has taken to defending Sarah Pailin and her pregnant daughter. I do not believe any defending needs to be done, but at least the Journal has a new bone on which to chew.


I would like to thank my readers for the kind words we have received during the GSE crisis. With all the negativity pervading the Street, our necks were very exposed (we could have looked like twits if the GSEs had been nationalized) and preferred holders wiped out). However, I believed that when all things were considered, even the most ardent GSE critics would come to realize that wiping out certain investor classes could do more harm than good.