The Zombie Currency

Definition of a Zombie company: In Japan, one way that banks get around the problem of writing off bad loans is by providing troubled companies with debt waivers or swapping their debt for equity. This method has been used to help the country's largest supermarket chain Daiei Corp. Analysts say this type of support is risky because it simply disguises the problem by shifting it from the company to the bank, keeping dying companies alive on minimal nourishment, and ultimately hurting competitiveness. Companies like Daiei are called "zombie companies" as it muddles along without any vigor or aim.

Now all you have to do is substitute Daiei with the USD, debt waivers with foreign currency reserves and Japanese banks with the Bank of Japan (quite possible the least competant of all Central Banks - now that is saying something). The USD perfectly fits the definition of a zombie currency.

The price action on the USD over the past 4 years (temporarily interrupted in 2005 by the Fed's tightening campaign) shows that foreign investors are losing their appetite for USD holdings. The last couple of weeks with the skyrocketing price of gold and silver along with a quick deterioration in USD in the fx markets may be warning us of an impending market dislocation.

Due to the $800 billion annual U.S. trade deficit, the global investment community has to purchase a net $2 billion + per day, every day, just to keep the USD from falling. Therefore, a slow, downward drip in the USD simply means that foreign investors are simply accumulating USD assets more slowly. If they were to actually start selling USD, then look out.

So who are these "foreign investors" that come to the rescue of the USD each and every day? Since the demand for USD assets from private investors is clearly slowing, it leaves the foreign central banks and governments. In fact, a term has been coined for these public sector investors, called "Non-Economic Players" (NEPs) - which is a euphimism for currency manipulators. These are mainly China and Japan, but include many other countries in the Middle East along with Russia, Brazil, and South Africa; maybe even Canada, the U.K. and Europe in smaller amounts.

The theory goes something like this. If the USD were to fall precipitously causing inflation, higher interest rates, lower real estate prices and general financial carnage - American consumers would no longer be able to live above their means and buy "stuff" on credit from foreign companies. This "stuff" ranges from cars to flat-screen TVs, to t-shirts, to oil, to any other gadgets or conveniences/necessities in our daily life.

To avoid this scenario where people actually have to pay for the stuff they buy, the NEPs "lend" a huge chunk of their export earnings back to the U.S. in the form of bond, equity, and real estate purchases (amongst many other types of investments). By buying these USD denominated assets in such gargantuan numbers, they artificially prop up the fx value of the USD.

And thus a zombie currency was born and perhaps a zombie economy with it.

The problem is that they are interfering with the adjustment process of the foreign exchange markets and have created unsustainable bubbles - which show up in the form of burgeoning U.S. trade deficits and the foreign reserve holdings of the NEPs. The larger the manipulations, the larger the imbalances grow - which in turn require even more manipulation.

What is the endgame? We will now see if the NEPs are willing to continue throwing away the money earned from the blood, sweat and tears of their citizens to prop up the zombie USD currency.

Of course, I have GROSSLY oversimplified this story and have not even mentioned the FED's role in this scheme. But the point of this commentary is highlight the Asian practice of creating and maintaining Zombies - besides I have hammered on Big Al and Hellicopter Ben (Bobby) enough over the past few months.

By the way, last week's article generated an amazing response. I had 25 e-mails by the time I woke up in the morning, mostly about my comments re: the housing market. This is clearly an emotional topic for many people. For further discussion, here is an article written by Mike Shedlock(http://globaleconomicanalysis.blogspot.com/) :