Many of the callers into the trade desk wonder how anyone would be buying the Japanese yen and US Dollar as ‘safe haven’ currencies. I think a lot of this buying of yen and dollars isn’t necessarily due to investors believing they are safer in US dollar and Japanese yen, but rather a result of the reversal of carry trades. The dollar and yen are the two major funding currencies of the carry trade. Investors borrow yen and dollars and then invest the proceeds into higher yielding assets including equities. This is what is called the carry trade, and it works best when an investor can use high leverage to increase the return. Since these trades are highly leveraged, they are closely monitored and reversed at the first sign of a possible fall in the value of the higher yielding assets. So while the popular press will talk about the ‘perceived safety’ of the yen and US dollars, I believe much of the dollar and yen buying is due instead to a reversal of the carry trade. Investors aren’t buying these currencies because they think the Japanese and US economies are stronger and therefore safer than others, but are simply deleveraging to take risk off the table, and are buying yen and US dollars in the course of this deleveraging.

So what caused investors to worry about their investments in the equity markets? Chuck sent me this note before heading out the door last night:

“I saw currencies jump around again on Wednesday… But here’s something that makes me scratch my bald head, and should make you wonder too… If you’re confused with this, then don’t feel alone… Fed Head Bullard was speaking yesterday and at one point he said… ‘FED MAY NOT START TO RAISE RATES UNTIL EARLY 2012.’ That really got the currencies going… But later in the same speech, he said, ‘MEMORY OF HOUSING BUBBLE MAY PUSH FED TO START RATE HIKES MORE QUICKLY THAN AFTER PAST RECESSIONS.’ WHAT? He said that the Fed may not start raising rates until 2012, but then says that the Fed may push to start rate hikes more quickly than before? In my best Andy Rooney voice… Do you ever wonder how these Fed Heads get in the door? Oh well… The second statement didn’t change the currencies, but it did change stocks… And for the first time in quite a while… US stocks sold off, and non-dollar currencies rallied.”

As Chuck points out, the St. Louis Fed Head Bullard seemed to be speaking out of both sides of his mouth, but his second statement that the Fed may push to start rate hikes more quickly than before scared equity investors. He stated that in the debate to tighten policy, “the idea that you might be creating asset bubbles by keeping rates too low for too long will be an important argument.” This is what scared the markets.

The economic data released yesterday certainly didn’t help investors’ confidence in the global recovery, as US housing starts unexpectedly dropped 11% in October compared to the month before. The pace of construction was the lowest since April’s record low, and illustrates housing’s reliance on government support. Obama has extended both the first time homebuyer’s tax credit and instituted a new (and I believe stupid) program to give existing homebuyers a tax credit to go out and buy a new one. These programs will probably give a bit of life support to the housing market in November, but many question just how long the government can continue them.

Another piece of data released showed that the cost of living in the US rose more than forecast in October as the price of gas pushed CPI up 0.3% following a 0.2% rise in September. Today we will get the weekly jobs data along with the leading indicators for the month of October. Last month’s leading indicators surprised the market with a 1% increase, but this month the expected rise is just 0.4%. This would be the seventh consecutive month of increased indicators begging the question: Just how LEADING are these indicators??? They have posted positive gains for seven months, but the economy sure doesn’t feel like it is picking up steam. Housing and unemployment continue to be drags on the US economy and, according to Chairman Ben S. Bernanke, economic ‘headwinds’ will limit the recovery for an ‘extended period’.

Speaking of our esteemed fed head, Bernanke’s clout among US lawmakers will be tested today as the House Financial Services committee will consider how much to expand audits of the US central bank. Panel members will be voting on a Democratic proposal to retain a ban on audits of the Fed interest-rate decisions. This would be a big blow to Ron Paul and his bill to allow audits of the Fed. Unfortunately I believe the Democratic ban on audits will pass, and Ron Paul will have to figure another way to try and hold the Fed accountable.

The worst performing of the currencies versus the US dollar over the past 24 hours is the New Zealand dollar (NZD), which fell by over 2%. The kiwi dropped as the nation’s main opposition party said it would no longer accept the central bank’s primary policy of targeting inflation. The head of the central bank’s salary is actually tied to keeping inflation rates at an acceptable level. This is one of the main reasons interest rates in New Zealand have been among the highest of industrialized nations. But in the opinion of the nation’s main opposition party, these high rates have been at the cost of slower growth and weaker exports. In my opinion, having a central bank focus on keeping inflation within a targeted range is absolutely required; and tying the main policy makers’ incomes directly to this objective is smart.

The Australian dollar (AUD) also dropped for a second day on interest rate speculation. As Chuck has written, the markets have expected the Reserve Bank to raise rates again at their December meeting, but the minutes of their November 3 meeting caused some concern that they will not raise rates again until 2010. The minutes, released yesterday, said the pace of interest rate increases is an ‘open question’ as policy makers balance the risk of inflation against an economy that could slow as government stimulus ends. But I am still firmly in Chuck’s camp, and believe the RBA will raise rates in December, and that interest rate differentials will continue to rally the Aussie dollar versus the US dollar.

Minutes of the Bank of England’s November meeting were also released yesterday, and showed that the policy makers were split on whether to extend the ‘quantitative easing’ program or possibly cut rates further. The pound sterling (GBP) lost ground against both the euro and US dollar as investors worried about the lack of direction. The minutes show there are three different camps at the BOE, one that favors expanding the program of pumping money into the system with bond purchases, another that favored no change, and a third that wants to use another interest rate increase to stimulate the economy. The lack of a clear plan by the central bank policy makers strikes fear into investors who want to see more of an agreement on the direction of policy.

While we don’t trade the Russian ruble, it is part of our BRIC MarketSafe CD (for which time is running out!). Chuck pointed out to me yesterday that the Russian ruble has been the best performing currency of the BRIC, which was surprising. A story overnight said that Russia’s central bank would have to accept a stronger ruble next year as rising commodity prices move the currency higher. Strong commodity markets have pushed capital into the Russian markets, pushing the ruble higher. Policy makers had indicated they would try to cap the ruble’s gains, but the IMF warned recently that these efforts to fight the ruble’s advance would prove ‘unproductive’ and that ‘underlying factors’ justify the ruble’s strength. This is good news for holders of the BRIC MarketSafe. If you haven’t purchased this latest MarketSafe CD, the cut-off is approaching – you only have until December 3, and then your opportunity is lost.

OK, to recap… The dollar rallied on carry trade reversals… The ‘audit the Fed’ bill is in jeopardy… Aussie and New Zealand dollars fell… And the BOE is split on the future of monetary policy in England.

Carry Trade Reversals Rally the Dollar and Yen originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Another number that was encouraging for economists was the large jump in non-farm productivity. US worker productivity spiked up an annualized 9.5% in October as employers found ways to squeeze more work out of existing employees instead of hiring new ones. This jump demonstrates one of the positive aspects of a severe economic slowdown. Contrary to what some reader’s of the Pfennig seem to believe, neither Chuck nor I are happy that the US continues to be mired in this economic recession. But business cycles are inevitable, and the more we ‘spend to extend’ the longer it will take for the recovery to take hold. The jump in productivity is one positive that comes out of an economic downturn. In the good times, companies become fat and happy, with many companies becoming very inefficient. The severe slowdown causes companies to rethink all of the processes, and worker productivity increases. This need for higher efficiency also encourages innovations to the manufacturing and service sectors.

Another piece of data due out this morning will illustrate another positive aspect of the economic slowdown. US consumer credit is expected to show another $10 billion drop. The highly leveraged US consumer is continuing to draw in their purse strings, ignoring calls from the administration to resume their old borrow and spend attitudes. While some of this belt tightening has been forced on consumers by the credit crunch, hopefully we will see this adjustment continue. This isn’t good news for retailers as we approach the holiday season, but if the global imbalances are to be corrected, US consumers are going to have to continue to increase their savings rate and decrease debt.

So there are a few silver linings to the economic cloud hanging over the US. The United States will eventually emerge from this economic storm with a leaner and meaner manufacturing sector and a much weaker dollar enabling it to better compete in the global arena.

Both the ECB and BOE kept rates unchanged. Officials at the Bank of England slowed the pace of bond purchases, but still approved the additional purchase of £200 billion. A rebound in factory output, which rose 1.7% (the largest gain in seven years) combined with a 0.2% increase in UK producer prices, caused the change of direction by the BOE.

ECB President Jean-Claude Trichet signaled the beginning of the end of emergency stimulus measures in Europe. Trichet said next month’s offer of 12-month loans would be the last. Data released yesterday was unable to paint a clear picture of the economic recovery in the Euro-area. German factory orders rose for a seventh month in September, as exports helped the recovery. But another report showed European retail sales fell for a 16th month, declining more than economists had predicted.

The euro (EUR) rallied a bit after the ECB decision, but Citigroup is predicting an even larger rally. A report by Citigroup stated that the technical trading patterns predict the euro will climb to $1.5064 short term, and move up to $1.5285 over time. It continues to look like Europe will recover, and the euro will move higher versus the US dollar.

The Norwegian krone (NOK) also moved higher as Norway’s central bank Deputy Governor Jan Qvigstad said it is ‘most probable’ the deposit rate will be moved another quarter-point higher by the beginning of 2010. Officials of the Norges Bank are attempting to hold down some of the appreciation of the krone as Norway continues to increase interest rates to combat rising inflation. Norway’s oil rich economy was one of the first to emerge from recession, so the central bank is also taking the lead on increasing interest rates. Yield differentials, along with a strong economy should keep the NOK among the world’s top performing currencies.

Speaking of the top performers, I was updating the return charts for the currencies yesterday and was amazed at the returns on the Brazilian real (BRL) and Australian dollars (AUD), YTD. Brazil is up 31.42%, and the Australian dollar has increased 28.05% during 2009. The Australian dollar continued to strengthen yesterday as the central bank signaled it would continue to increase interest rates in the coming months. “A further gradual lessening of monetary stimulus is likely to be required over time,” the Reserve Bank said in Sydney today. A rally in commodity prices, along with increasing interest rates will push the Aussie dollar toward parity with the greenback.

To recap… Silver linings of the current economic storm cloud: increased worker productivity and decreased consumer credit. The ECB and BOE kept rates unchanged. And Aussie dollars continue to move closer to $1.

What’s the REAL Unemployment Rate? originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

As just mentioned, the leading indicators for the US rose in September for a sixth straight month, giving confidence to those calling for continued expansion in 2010. The gauge that attempts to predict the economic outlook for the next three to six months climbed 1%, beating most economists’ forecasts. But much of the good news on the US economy is due to the government stimulus programs, and two other reports indicated that future growth for the US is still a question mark.

Offsetting this positive report were the weekly jobless claims – which rose – and a report that showed home prices fell. So apparently the leading indicators are predicting a recovery without jobs, and without a strong housing market. You can see why Chuck and I question reports of a 2010 recovery. The US economy will not be able to post strong growth with near double-digit unemployment and with both residential and commercial real estate in the dumps.

One of the Fed heads agrees. Federal Reserve Bank of Boston President Eric Rosengren said that the US economy is at risk of relapsing into recession after expanding in the second half of 2009. “It’s certainly a risk,” Rosengren said in an interview with CNBC. “That is why we don’t want to take away the stimulus too quickly.” I don’t look for the Fed to move interest rates higher anytime soon; the leaders of our Fed realize a full US recovery is still a ways off.

Here is a question that needs to be asked: Can the world grow without a robust US consumer? I believe the answer is yes! Growth in Asia and Europe can propel the world out of the global recession without the help of the US consumer; and I think that there is a very good chance that that is what is going to happen. Chuck has compared the current state of the US to what happened in Japan after its stock and real estate markets crashed in 1990. Japan plunged into a 10-year period of stagnant growth while the rest of the global economy prospered. Many will question how the global economy can grow without the help of its largest contributor, but Japan was the second largest economy during the ’90s, and the rest of the world barely skipped a beat during their malaise.

With the emergence of the consumer in both China and India, the global economy can and will continue to grow even if the US is stagnant. I read a report this morning that stated China would create over 11 million jobs this year, 2 million more than the government had earlier predicted. These new jobs will continue to increase the standard of living in China, and create 11 million ‘new’ consumers.

While the current administration may talk about reversing the stimulus and government spending as the rest of the world starts to recover, their actions won’t match their talk. I believe we will see interest rates stay low in the US for an extended period of time. We will also probably see additional stimulus proposals as US unemployment continues to rise and US consumers continue to tighten their purse strings.

As the rest of the world continues to recover, and central banks begin to increase rates in order to fight rising inflation, the US dollar will continue its slide. A strong dollar just isn’t in the interest of the US if we have any plan to try and pay down the tremendous debts and stimulate growth through increased exports. The dollar will fall victim to policies which will be designed to try and push the US economy up to keep pace with the global recovery occurring in Asia and Europe. Despite all of the rhetoric about a ‘strong dollar policy’, the administration is willing to sacrifice the dollar in order to keep the US from slipping further into recession.

I don’t think this is the right course to take for the US, but I firmly believe this is what is going to happen. The future is too far off for politicians to worry about; they focus on the short two-year election cycle. They will continue to leverage the future of America with borrow and spend policies designed to keep the US economy on life support until it magically recovers. Their policies will cause a dramatic fall in the value of the US dollar, which will eventually make our exports competitive and finally spur growth in the manufacturing sector. This drop in the value of the US dollar will also enable us to pay down our debts to foreign holders with cheaper US dollars.

I am not suggesting that the US will slip into a ‘great depression’, but I believe we will see an extended period of stagnant growth. Certain well run companies (like EverBank) will still be able to make a good profit, and the falling dollar will create opportunities for companies with a strong international presence. As an investor, you should look to hedge your portfolio against the inevitable fall in the value of the US dollar by investing in non-dollar assets such as our WorldCurrency and MetalSelect accounts.

One major problem the sliding dollar causes for the rest of the world is that the price of oil is inversely related to the value of the dollar. As the dollar has steadily declined this year, the price of oil, which is priced in dollars, has risen. In fact, a study released yesterday showed that oil is relatively cheap at $80 per barrel. The study showed that the price of oil should be $88 per barrel with the euro (EUR) trading at $1.50. As the dollar continues to slide, there will be further calls for oil to be priced and traded in some other currency besides the dollar, as countries try to de-link it to the falling greenback. If this would occur, it would be a major blow to the reserve status of the US dollar.

And the folks at PIMCO, the global bond giant based in California, seem to agree. Richard Clarida, a strategic adviser at Pimco wrote a note to clients yesterday pointing to “an orderly dollar decline” as the “most likely scenario”. He added, “a disorderly decline, while unlikely, cannot be ruled out.” In the note, he states that a collapse in the value of the dollar would jeopardize its status as the world’s reserve currency. Not a rosy picture for the greenback.

Both the central bank of Sweden and South Africa announced they would be keeping rates unchanged yesterday, but the announcements have very different effects on the values of their currencies. The Riksbank of Sweden stated that they would keep their benchmark interest rates at 0.25% and said that that level would be maintained until ‘autumn’ of next year. The Swedish krona (SEK) slid against the dollar after the announcement.

South Africa also left their rate unchanged at 7%, but the rand (ZAR) rallied as some had expected a 50 basis point cut. South Africa’s central bank leaders said rising energy costs had added to inflationary pressures, and therefore rates would have to be maintained at their relatively high levels. The rand rallied after the announcement.

As mentioned earlier, the big loser overnight was the pound sterling, which fell over 1.5% versus the dollar. A report this morning showed that UK gross domestic product unexpectedly dropped in the third quarter, falling 0.4% from the previous three months. The British economy has now shrunk over six consecutive quarters, the most since records began in 1955. The report confirms the BOE will continue to keep the ‘quantitative easing’ policies of low interest rates and government purchases of debt in place. Both Chuck and I have railed against these policies, as they are largely untested, and will likely lead to a spike in inflation down the road. Unfortunately the US has been following the UK in their attempts to borrow and spend their way out of recession. I don’t think the future is too bright for either the pound sterling or the dollar.

Before leaving work yesterday, Chuck wrote me the following to add to today’s Pfennig:

“Canada posted a stronger than expected retail sales in August, printing at +0.8% (forecast at +0.4%)… Then that report was followed by the Bank of Canada’s (BOC) Monetary Policy Report for this month, in which the BOC admitted that ‘Canada’s economic recovery is due to monetary and fiscal stimulus, increased household wealth, improving financial conditions, higher commodity prices, and stronger business and consumer confidence.’

“Hmmm… Seems to be the same exact things I’ve been saying about Canada!

“There is an important point in on the items the BOC talked about… And that is the stimulus… Once in a while I get notes from people telling me I bang on the US for stimulus when every other country in the world did the same thing. Well, not quite… While every other country might have implemented stimulus, they were in a fiscal position of strength to do so, while we merely raised the national debt to levels that now place more than $38,000 of debt on each civilian in this country! So… There was a difference, folks… And that leads me to the point I’ve tried to make for years now, and that is why it is so important for a country to be a surplus country!

“Colleague Aaron Stevenson brought this to my attention yesterday regarding the price of gold… The charts show that the price of gold basically traded back and forth for a flat result for six months prior to August 25, 2009.

“From August 25th of 2009, gold has gained 12%! So… Guess what was announced on August 25th that probably has a ton to do with this gain in gold? Give up? August 25th was the day that the President announced that Ben Bernanke would be reappointed Fed Chairman…

“Co-inky-dink? I don’t think so!”

I really appreciate it when Chuck gives me these notes to get me going when I am pfilling in for him. It gets the juices flowing instead of staring at a blank sheet of paper!

Both the high flying Australian (AUD) and New Zealand dollars (NZD) fell a bit versus the US dollar yesterday as investors worried about China pulling back there stimulus. The currencies, which were trading near their 14-month highs, were ripe for profit takers after China announced accelerated growth in the third quarter. With China clearly back on the growth path, some investors feared they would reverse some of the stimulus programs put into place over the past year. China will certainly start to pull back some of their expansionary policies, but I think this was just a good opportunity for ‘traders’ to book some nice profits. The Chinese economy will continue to grow, and their demand for raw materials will keep the exporters of Australia and New Zealand busy. As Chuck stated the other day, this isn’t a crying opportunity but is rather a buying opportunity! We still feel the Aussie dollar is a solid currency to own.

Jobless Recovery Not Going to Happen originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The dollar dropped again yesterday as investors continued to move money out of the ‘safe haven’ investments in favor of higher returns. The two places where investors sought refuge during the economic crisis were the US dollar and Japanese yen (JPY). Investors felt a level of comfort in the currencies of these countries because they are the world’s largest and most advanced marketplaces. With the credit crisis gripping the globe, investors were satisfied pulling money off the table and ‘parking’ the funds in ultra low-rate accounts in Japan and the United States.

With the latest data showing the global recovery taking hold, investors have moved out of these low rates and have sought out higher returns. Some of this money has flowed into the equity market in the US, pushing the Dow Jones average back above 10,000 (more on that in a second). The global recovery also has investors looking toward commodities, which were beaten down on fears of a global slowdown. The price of copper, gold, and crude oil have all run up on fresh signs of a global recovery. With commodity prices coming back up, the countries that are commodity rich should do well, and investors have returned to the currencies of Canada (CAD), Australia (AUD), and Norway (NOK).

Finally, investors who feel more confident have begun to take on a bit more risk, with many returning to what was once a very profitable trade: the carry trade. This trade dominated the currency markets for a number of years prior to the global economic crisis. While long-term readers know all about it, I will give another quick explanation for those of you who are new to the Pfennig. The carry trade is simply a trade where investors borrow at low interest rates and then invest the borrowed funds at higher interest rates. The trade typically uses a high degree of leverage in order to make even a small interest rate differential profitable. The most popular funding currency of the carry trade had been the Japanese yen, as interest rates in Japan were held at near zero levels for several years. Investors would borrow the yen at 1%, sell the yen and use the proceeds to purchase New Zealand dollars (NZD), and then invest these kiwis at a rate of 5%; earning the spread of 4% (before fees). As long as the currencies remained relatively stable, the profits rolled in. The risk to this trade occurs when the funding currency starts to move up versus the investment currency, and the leverage used can make these currency moves pretty dramatic.

But enough of the history lesson; let me get back to where we are today. The US dollar has replaced the Japanese yen as the most popular currency for the carry trade. Investors have been selling dollars and moving funds into the higher returns of Brazil (BRL), South Africa (ZAR), and even Mexico (MXN). These countries have the attractive combination of high interest rates and commodity-based economies that should do well in a global recovery. But as I mentioned above, investors in these carry trades can be a bit fickle, and can reverse these trades at the first sign of trouble. These currencies can be volatile, and should be viewed as the speculative portion of your currency investments.

The last few months have been a sort of ‘perfect storm’ for the currencies of Australia and Norway. Both have benefited from the surge in commodity prices. Both also have strong governments that kept their respective economies from dipping too far into recession. Because of this fiscal strength, both countries are now raising interest rates, which continues to make their currencies more attractive. The Norwegian krone climbed to a one-year high against the euro (EUR) and the dollar yesterday as crude oil prices jumped. With Norway putting a percentage of their oil revenues to work rebuilding their economy, their central bank will probably start raising rates at their next meeting. The Norges bank governor Svein Gjedrem said last month the bank had considered raising rates at the September 23rd meeting and will likely have to take a fairly aggressive stance on rates going forward.

Australia was the first to raise interest rates, and will likely continue to tighten. Reserve Bank Governor Glenn Stevens told reporters that the RBA can’t be too timid in raising rates now that the threat of an economic crisis has passed. “If we were prepared to cut rates rapidly, to a very low level, in response to a threat but then were too timid to lessen that stimulus in a timely way when the threat had passed, we would have a bias in our monetary policy framework.” Unemployment is falling, and consumer confidence continues to rise in Australia, which will likely mean additional interest rate increases in the next few months.

Investors in our newest WorldCurrency Index CD have been perfectly positioned for these latest currency moves. We introduced the Global Power Shift CD back in July of this year and it has been one of our best performers. This CD combines Australia, Brazil, Canada, and Norway into one mighty index CD. Ty Keough mentioned the other day that he had spoken to one of the first investors in the Global Power Shift, and had calculated the customer had earned an amazing 12.5% during the first three months (that is a 50% annualized return!!). With commodity prices continuing to push up, and interest rates set to rise in both Norway and Australia, investors should continue to see good returns in this WorldCurrency Index CD.

As I mentioned above, the Dow Jones average moved back above 10,000 yesterday. Investors have apparently taken the same view as the Nobel Peace Prize committee and are betting on the ‘good things to come’. I just don’t see any concrete evidence of a sustainable recovery here in the US. Unemployment continues to hover near double digits, and US foreclosure filings have climbed to a record high. While ‘less negative’ numbers on the retail sales may have inspired some mis-directed optimism, the US economy is still in a very precarious position. I know equity investors always have to look at ‘future’ cash flows and purchase stocks on the promise of earnings coming in somewhere down the road, but I don’t see where the current data supports a Dow at 10,000.

The retail sales numbers reported yesterday here in the US were ‘less negative’ than expected, dropping 1.5% versus a predicted 2.1% drop. The press proclaimed the return of the US consumer confidence since this number was better than predicted. I guess as long as the data comes in a bit better than what the economists predicted it is positive (no matter what the actual data is!). Today we will see data on consumer prices, which are predicted to show that inflation continues to be muted. The volatile Empire Manufacturing report will also be released this morning and will show another jump.

If the inflation data come in as expected, the news will give the upper hand to FOMC members who have said the central bank can keep interest rates low for a long time. The minutes of the FOMC September 22-23 meeting showed that some members were actually calling for an expansion of the ‘quantitative easing’ program. Chairman Ben Bernanke said the Fed is prepared to tighten credit when the economic outlook ‘has improved sufficiently’. But the minutes show that the Fed is actually leaning toward a more expansionary program. There seems to be absolutely no fear of future inflation, so look for rates to remain low for some time to come. This will continue to keep downward pressure on the US dollar.

I wrote yesterday how the US is following the BOE’s lead when it comes to ‘quantitative easing’. These programs had led to a drop in the value of both the UK pound sterling (GBP) and the US dollar. But overnight, the pound sterling stormed back up versus the US dollar as The Financial Times cited the BOE Markets Director as saying policy makers would be more likely to pause asset purchases, giving themselves the option of ‘doing more later’, rather than stopping them. A report yesterday showed that UK unemployment rose less than forecast last month causing some of those investors shorting the pound to reverse course. I have to believe a lot of the pound’s movement is simply profit taking after the sterling lost 3.5% versus the US dollar in the past month. I still believe the pound sterling will have a tough going as long as they continue with their QE programs.

I will end today’s Pfennig with a prediction from Goldman Sachs. You may have seen where Goldman reported another quarterly profit of $3.2 billion yesterday. The profit is really no surprise when you understand just how far ‘inside’ Goldman is with the administration. Given their position, I always like to read what Goldman is predicting for the currencies. Their latest report said the dollar is likely to extend drops against the euro and commodity-backed currencies over the coming six months (sound familiar?). The euro is now predicted to reach $1.55, revising previous forecasts of $1.45. “It now looks as though the dollar trough will be slightly deeper,” Goldman analysts said.

The Return of the Carry Trade? originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

European industrial output rose for a fourth month in August, increasing just below 1% from July. From a year earlier, August output fell 15.4%, a big drop but still the smallest YOY decline in eight months. The euro (EUR) area continues to recover ‘at a gradual pace’ according to ECB President Trichet. The positive news coming from the manufacturing sector is a good sign the European economic recovery will be sustainable.

Another report overnight showed that China’s exports fell by the least amount in nine months during September. As we have written over and over again, China will lead the world out of the global recession, and the latest reports show China beginning to pull away. Reports due out next week will likely show that China’s economic growth accelerated to 8.9% in the third quarter, slightly above the government’s target.

China has used the economic downturn to lock in a dominant position in world trade, and has replaced Germany as the world’s biggest exporter. During the first seven months of this year, China has moved past Canada as the number one supplier of imported goods to the US with 19% of all imports entering the US originating in China. These exports continue to bolster China’s foreign reserves, which climbed $141 billion in the third quarter to a record $2.273 trillion. China has decided to keep their currency pegged to the falling dollar, which has helped them increase their exports leading to additional growth in their currency reserves.

The Chinese government is now looking to leverage their huge reserves to attain a more dominant role in the post-crisis global financial order. A story in the China Daily predicted Bank of China Vice-President Zhu Min would soon take up a crucial post at the International Monetary Fund (IMF). According to the Chinese paper, “Zhu’s appointment at the IMF will be a significant step toward breaking up the US and Europe’s dominant position in the international financial stage”. Welcome to the new world order!

Today we will finally get some data in the US, with the release of retail sales, business inventories, and the monthly budget statement. We will also get to read the minutes of the Sept 23rd FOMC meeting, this afternoon. Retail sales is the number to watch, and it is expected to have dropped by over 2% with the end of the ‘cash for clunkers’ program. If the data come in as expected, it will confirm that the US consumer will not be able to sustain their spending as the government stimulus fades. So while Europe and China look to be expanding, the US is bogged down with rising unemployment and weak growth.

I can pretty much predict what the administration will say after seeing the report: It is obvious that we need to have another stimulus package!! The administration thinks the way out of this mess is to borrow and spend, and if the US consumers won’t do it on their own, the government will be more than happy to spend our money for us. But President Obama’s effort to spend us out of recession is undermining the US dollar. In spite of his pledge to keep the dollar strong, the dollar index is down 10% during the first 8 1/2 months of Treasury Secretary Tim Geithner’s term.

And the boys over at the Federal Reserve certainly don’t seem like they want a strong dollar either. Fed Vice Chairman Donald Kohn put a shot across the dollar’s bow yesterday when he said interest rates would remain low for an ‘extended period’. I expect the minutes of the FOMC meeting – released later today – will show the members continue to focus on the short-term and have turned a blind eye to the threat of future inflation. The dovish tone that the Fed has taken will continue to push the dollar lower.

I read the following quote in an article on Bloomberg that I thought was dead on: “The all night printing runs at the Treasury are chipping away at the dollar’s ability to hold value compared to other currencies and commodities,” Mike Sander, of Sander Capital said yesterday. “With dollar weakness, inflation fears, a huge budget deficit, energy prices creeping up, metals such as gold, silver, and copper will be pushed up in price.” Sounds like Mr. Sander is a Pfennig reader!!

As I pointed out in my opening paragraph, commodity prices have surged on the positive economic news from China and Europe. Demand by China continues to support the market for raw materials, and a falling dollar has created additional demand. The prices of oil, gold, and copper all moved higher yesterday and brought the currencies of Canada (CAD), South Africa (ZAR), and Norway (NOK) along for the ride. The South African Rand and Norwegian Krone were both up nearly 1% versus the US dollar, and the Canadian loonie moved a bit closer to parity. Norway’s finance minister helped push the krone higher with the announcement that their stimulus efforts will generate an extra 0.5% of economic growth next year. The Norges Bank considered moving interest rates higher last month, and looks poised to deliver a rate increase at their next meeting.

I know I will get some emails accusing me of being hypocritical, bashing the US and UK stimulus plans while praising those of Norway and China. The big difference between these plans is that Norway and China are spending money they already have, while the US and the UK are borrowing in order to spend. Norway is spending some of its $450 billion oil fund in order to stimulate their economy, and China has been spending some of their record reserves. These stimulus plans will be less inflationary than the ‘quantitative easing’ being instituted by the US and UK.

Gold benefited from the good economic news and a push by investors to diversify out of US dollar holdings. Gold advanced to a record level for a second day as investors increased purchases in order to hedge against a falling dollar and the possibility of future inflation. A report I read this morning predicts further price gains by gold: “A weakening US dollar and easy liquidity conditions will particularly favor precious metals,” Morgan Stanley analysts said in a report today. “We expect prices of gold, silver, and platinum all to register further gains over the next year.” Gold at $1,100 looks like a done deal in the face of increased investor appetite for dollar alternatives.

US Borrow and Spend Policies Continue originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

European currencies were helped by good news over the weekend as Poland ratified the drafted EU constitution (referred to as the Lisbon treaty). But one big hurdle still remains: Czech President Klaus is refusing to sign the treaty, even though the Czech government has approved it. The Czech President, who is against the EU, is hoping to stall until after the British election, which must be held by June of next year. David Cameron, the Conservative leader, has pledged to hold a referendum on the treaty if his party is elected. This would throw the EU constitution back into question, so EU leaders are putting major pressure on the Czech President. While the pursuit of this last signature makes for good drama, I believe the EU constitution will be ratified, and the European Union is not in any immediate danger of falling apart.

In fact, the euro (EUR) has quickly become one of the preferred investments for central banks who are looking to diversify out of US dollars. As Chuck wrote in yesterday’s Pfennig, the latest data shows that central banks placed 63% of new reserves into euros and yen (JPY) in April, May, and June. Foreign currency reserves were increased by $413 billion during the last quarter, the most since 2003. In the past, a majority of these reserves would have been invested into US dollars, but central banks are now shying away from the greenback.

Recently, the roles of the dollar and the euro/yen have been reversed. Previously 63% of new reserves were placed into US dollars, but lately that number has fallen to just 37%. As Chuck and I have written in recent Pfennigs, the current administration has no interest in supporting the US dollar, and global central banks seem to be fearing this lack of support. According to the data reported by Bloomberg, the dollar will likely remain under selling pressure for some time to come. Despite last quarter’s move away from the greenback, central banks still hold over 62% of their foreign currency reserves in US dollars, leaving plenty for future sales.

Some of the largest pools of reserves are being held by China, Japan, Russia, and India. Both China and Russia have repeatedly called for the creation of a ‘new’ reserve currency, so their moves out of US dollar come as no surprise. China, which controls $2.1 trillion in foreign reserves is the largest holder of US debt with over $800 billion invested in US treasuries. Investors would be wise to take notice of where these countries are moving their reserves. Pulling reserves away from the dollar will continue to rally the alternative currencies of the euro and yen; and will also put upward pressure on the price of gold, which is another attractive alternative for reserves.

As I mentioned above, leaders in the UK will be forced to call an election by June of next year. Prime Minister Gordon Brown has been trailing Conservative leader David Cameron in opinion polls and the sagging British economy isn’t helping his position. Mr. Cameron has been calling for an end to the ‘quantitative easing’ and a focus on the ballooning deficits. The Treasury expects its deficit to touch £175 billion this year, about 12% of national income and the most in the Group of 20 nations. Brown wants to sell assets including the government’s stake in the Channel Tunnel and increase taxes in order to halve the budget deficit in the next four years. I have to side with the conservatives and Mr. Cameron on this one. I just don’t see how increasing taxes and selling off assets in order to continue to pump money back into the economy is a positive long-term strategy.

What scares me is that Prime Minister Brown’s plan has the stamp of approval of economists at Goldman Sachs. Readers know the influence the folks over at Goldman have on our administration. The US followed the Bank of England down the path of ‘quantitative easing’, and we will pay the price for these inflationary policies in the not-to-distant future. Why jeopardize the long-term health of your economy for short-term growth? But politics leads to some poor decisions, and Brown can’t risk falling back into a ‘double dip’ with elections coming up around the corner. The same can be said of the US administration, with mid-term elections looming in 2010.

The pound sterling (GBP) fell to its lowest level in several months versus both the US dollar and euro yesterday as speculation of an increase in the ‘quantitative easing’ programs ran through the markets. The UK inflation rate dropped in September by more than forecast, to the lowest level in five years. With inflation continuing to run below the radar, pressure will continue for the BOE to pump more newly created money into the markets through asset purchases.

Questions over Brown’s economic policies and the uncertainty of the upcoming election will certainly keep up the selling pressure on the pound. I read a research report over the weekend which predicted the pound sterling would continue to drop, bottoming out as low as $1.45 if Brown’s Labor party were able to hold on in the upcoming election. On the other hand, the report predicted the pound would rise to $1.85 by the end of 2010 under a Conservative Party win.

The Asian currencies were the worst performers yesterday, selling off on speculation central banks would take advantage of the light markets to intervene. This is a perfect example of how ‘jawboning’ can work. Asian central banks have been expressing concern on the recent strength of their currencies as compared to both the US dollar and Chinese renminbi (CNY). Since the Chinese have decided to ‘peg’ their currency to the falling dollar, other Asian nations with free floating currencies have been put at a competitive disadvantage. With many traders in the US gone for the holiday, it was a perfect time for some verbal intervention by Asian central banks. The South Korean government said it would intervene to stop excessive volatility, and Taiwan said it would introduce measures to deter speculators. This verbal intervention had the desired effect, and temporarily reversed the ascent of the Asian currencies versus the US dollar.

But overnight, these currencies surged back as the region continues to be the first to recover. Reports released show growth in Malaysia, South Korea, and Indonesia will be higher than previously predicted. Verbal intervention just can’t compete with strong economic reports. The data doesn’t lie, and it shows Asia will continue to take the lead in this global recovery.

The Indian rupee (INR) moved higher after a report was released which showed a big jump in industrial production in India. Output at factories, utilities, and mines jumped 10.4% in August from a year earlier – the largest jump in almost two years. The larger-than-expected move will increase pressure on India’s central bank to begin to raise rates. Central bank Governor Subbarao said last week that India may need to act ahead of advanced economies due to the ‘incipient’ inflation pressures.

While most have predicted a move up during the first part of next year, some now believe we could see a 50 basis point hike as early as the October 27 monetary policy meeting. India has been overshadowed by the growth story in China, but India’s growth is expected to keep pace with its larger neighbor. India also enjoys a more established economic system, a more educated workforce, and a higher standard of living than China. The central bank has reduced taxes on consumer products and imports, and cut interest rates to provide a stimulus worth more than 12% of India’s GDP. If the Reserve Bank does boost rates later this month, the rupee could enjoy a continued rally versus the US dollar.

One of the currencies with the biggest gains versus the US dollar overnight was the kiwi (NZD). Chuck noticed the currency rallying late last night and sent me this from home: New Zealand’s retail sales rose in August at more than twice the pace expected by economists, adding to signs the economy’s recovery from recession is gathering pace in the second half of this year. Sales increased 1.1% from July, seasonally adjusted – statistics New Zealand said in Wellington today. Core retail sales, which exclude car yards, fuel outlets and workshops, rose 1.2%.

I think this just may move RBNZ Governor Bollard to move rates earlier than he had wanted to… But like I said last week in my rant and memo to Bollard, who is known as someone who likes to talk down his currency… “Don’t you want your currency to move higher versus the dollar? Then don’t raise interest rates!” Unfortunately for Mr. Bollard, he’s trying to paddle against the current right now… So, unless he wants to face the music that comes from soaring inflation in the future, he’ll have to raise rates… And suffer through a rising kiwi!

The Benefits of Reserve Diversification originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

When asked about the recent fall of the US dollar, and the possibility of currency intervention, Trichet repeated the standard line saying, “excess volatility and disorderly movements” hurt growth; and policy makers “will continue to monitor the exchange markets closely and cooperate as appropriate”. Trichet also stated that he trusts his US counterparts (big mistake!) as to their statement on the strong-dollar policy. “When the Secretary of the Treasury and our friend Ben Bernanke say that a strong dollar is in the interests of the US economy and that they are pushing a strong dollar policy, this is a judgment that is obviously very important for us and the global economy.” NOTE TO TRICHET: YOU CAN’T TRUST A CHEATER!!

The current administration may say they support a strong dollar, but their actions sure don’t show it. Quantitative easing efforts have pumped a record amount of liquidity into the markets, and Washington has the printing presses working overtime. Unless the laws of supply and demand have changed, all of these US dollars that have been created will cause the value of the dollar to drop. We have seen a 15% drop in the value of the dollar index in the past six months. The current administration has no reason to support a strong dollar, and realize there is no way they are going to be able to protect the value of the dollar while pursuing their ‘quantitative easing’ policies. In order to protect the dollar, Geithner and Bernanke would need to shut off the printing presses, and actually put them in reverse, pulling liquidity out of the markets. There is absolutely no way this will occur anytime soon.

The Bank of England also left rates unchanged and announced that they would continue to push money directly into the economy through purchases of government and corporate bonds. At least one of the policy makers in England seems to understand what is going on. Conservative leader David Cameron stated today that the policy will lead to inflation, signaling to his party’s annual conference that it would stop the government’s main economic stimulus program if it wins the next election. “Sometime soon that will have to stop because in the end printing money leads to inflation”, Cameron said. But others remain trapped in their own twisted reality with former BOE officials calling Cameron’s remarks ‘dangerous’.

The dollar moved up a bit versus the euro (EUR) and pound (GBP) after the announcement, but fell again overnight. Overall, the greenback is up compared with yesterday morning, with the biggest moves coming against the New Zealand dollar (NZD) and Japanese yen (JPY). Asian central banks intervened heavily in the currency markets on Thursday to help support the US dollar. With China keeping the renminbi (CNY) stable versus the US dollar, other Asian currencies not pegged to the falling dollar have risen. Governments in Japan, Thailand, Hong Kong, and Singapore were big buyers of US dollar yesterday and continued with their purchases overnight. And while their efforts may work to slow the dollar’s decent, it won’t change the direction. These central banks just don’t have the financial power to change the inevitable fall of the US dollar.

Data released yesterday showed that initial jobless claims in the US fell slightly to 521K, and that continuing claims also drifted lower. Both are still near historic levels, and don’t support the claims that the US economy is pulling itself out of the recession/depression.

In other news, chain store sales managed to eke out a small increase in September. While the news caused a rally on Wall Street, the YOY increase was mainly because the stores had absolutely abysmal sales one year ago. The largest industry group is cautioning against reading too much into the increase, and to continue to predict a decline in sales for November and December.

In another report, the Commerce Department said wholesale inventories fell 1.3% in August, worse than the 1% drop economists had expected. This follows a 1.6% drop in July, as businesses continue to reduce inventories.

Today we only have one piece of data, the trade balance, which is expected to show a deficit of $33 billion for August. This deficit comes in spite of a falling US dollar, which should eventually make our exports more competitive, and force a narrowing of this balance. The continued deficit forces the US to have to attract foreign capital as imports continue to outpace exports.

Canada got a good piece of news yesterday as Canadian employers added jobs for the second straight month in September. The unemployment rate fell to 8.4% as employment rose by 30,600. The report will increase pressure on the Bank of Canada to raise interest rates from record lows, and could lead to strength in the Canadian dollar (CAD). We have been supporters of commodity based currencies, and Canada certainly has an abundance of raw materials. Their proximity to the US has caused some concern, as the US is still their largest trading partner, but Canada has worked to strengthen ties to China and is now enjoying an increase in exports to Asia as the recovery takes hold in the Far East.

An associate from headquarters down in Jacksonville emailed me last night to ask my opinion on recent events in Latvia. Now I certainly try to stay informed on all of the countries around the globe, but had to be honest and tell him I haven’t really ever looked at what is going on in Latvia. But after doing a bit of research, I realized what had sparked the question. Economic troubles in the Baltic state led to concern over the future health of Swedish banks. Plunging property values in Latvia have left borrowers ‘upside down’ on their mortgage loans, which are mainly provided by Swedish banks. The Latvian government had announced a plan to protect homeowners from foreclosure, angering Sweden. But overnight, Latvia has announced it is pulling away from its earlier plan, and would come to an agreement with its international lenders. It looks as if the ‘Latvian’ crisis will be resolved, and Swedish banks will avoid the possible losses that could have occurred. The Swedish krona (SEK) is unchanged on the month, and has increased over 12% in the past three months. With the Latvian crisis avoided, the krona will likely resume its move higher versus the US dollar.

After hitting an all-time high yesterday, gold slipped back slightly overnight. This was the first drop in the gold price this week, after the biggest weekly advance since April. We had expected a pause in the rapid ascent for gold, and a small move higher by the US dollar has pushed gold lower. Many traders are now calling for a near-term correction in the price as investors take profits from the rapid move. According to an analyst at HSBC: “The likelihood that long-term dollar weakness will support gold does not obviate the fact that the near-relentless increase in bullion prices recently has raised the possibility that gold is due for a pullback,” HSBC Securities analyst James Steel said in a report emailed today. “A dollar rally, even if only temporary, could provide a reason for gold longs to take profits.”

Don’t Trust the Dollar Strength originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

European industrial orders increased more than economists forecast in June rising 3.1% from May. This was the largest gain in over a year and a half, and is the latest sign that the European economy is starting to climb back out of recession. But many economists question the strength of the recovery, saying that the pick up in economic growth was mainly due to government programs. ECB President Jean-Claude Trichet sounded cautious after the report. “We see some signs confirming that the real economy is starting to get out of the period of freefall,” Trichet said in Jackson Hole. But this “does not mean at all that we do not have a very bumpy road ahead of us.”

The home sales data released in the US on Friday were surprisingly strong, with existing home sales increasing 7.2% month on month. We get a bit of a break in the data releases today with just the Chicago Fed index; but the rest of the week will give us plenty of data to digest. Tomorrow we see the S&P/CaseShiller housing data, US consumer confidence, and ABC consumer confidence numbers. Wednesday will bring Durable Goods orders along with New Home sales. Thursday will give us another look at the estimate for second quarter GDP here in the US along with the weekly jobless claims. And we will close out the week on Friday with the release of personal income and spending for July.

Should be a busy week ahead, and I would expect for most of the data out of the US to continue to confirm that a government led recovery is underway here in the US. In particular, the consumer spending and durable goods orders should show a nice uptick on the back of the “cash for clunkers” program. But Chuck sent me a note over the weekend that questions the “success” of this program. Is it really what the US economy needed? Here are Chuck’s thoughts from San Francisco:

“I was sitting here thinking about something that had flashed across the TV screen here in my room: the ‘Cash for Clunkers’ program… I blasted this program two weeks ago, and now that it’s finally done with, and $3 billion was spent to artificially boost auto sales, I will put my final thought on this… I believe the program is going to end up hurting the most vulnerable consumers in the US. Middle class buyers, traded in their “paid for” cars, and leveraged up to buy a new car, when they probably shouldn’t have done so, given the rot on the economy’s vine.

“So… Once again, I’m reminded of the words that President Reagan said were the scariest words that could be spoken… ‘I’m from the government, and I’m here to help’…

“The reason I’m all over this program like a cheap suit today, is that over weekend I heard that Big Ben Bernanke make a claim at the Jackson Hole boondoggle, that ‘we saved the world’… Oh, come on, Big Ben… Isn’t that just a bit dramatic? Does this statement have anything to do with the fact that you are up for reappointment in January, and you would love to have that thought of you ‘saving the world’ on the minds of the administration?

“So… In the end, we’ll just have to wait and see if he really did ‘save the world’…”

I’m with Chuck on this one. It seems the US government is intent on getting consumers to go back to their borrow and spend habits. This is what created the bubbles, and the administration seems intent on creating another bubble economy. US consumers have made some historic cut backs on the amount of debt they are amassing (whether or not these cutbacks are by choice). The US government should not be encouraging these consumers to go back to their previous ways, but should instead be trying to use the funds to educate and train consumers and to encourage new and innovative companies. Use this downturn to correct some of the bad habits that we had gotten into. Yes, it will be painful, but breaking an addiction is always hard and painful. US consumers need to break their addiction to easy credit and massive debt. This recession/depression has given consumers a much-needed wake up call; hopefully the administration won’t be able to push consumers back into their old habits.

I went running with my wife and her friends over the weekend (trying to take it easy on the back) and got into a discussion about the US economy. One of my wife’s friends had heard an interview on MSNBC in which an economist stated we were in a classic ‘V’ shaped recovery. I let her know that I thought the economist was one letter off, and that instead we will see the recovery shaped more like a ‘W’. The green shoots and recovery we are seeing right now will die out as government stimulus slows. High unemployment, a long slow housing recovery, commercial real estate woes, and rising personal bankruptcies will force the economy into another dramatic downturn. Central banks who have ‘juiced’ their economies with unlimited credit will have to decide whether to continue juicing, or pull back from the table.

Nouriel Roubini wrote a commentary in today’s Financial Times that agrees with my thoughts. Roubini said that the chance of a double-dip recession is increasing because of risks related to ending global monetary and fiscal stimulus. He believes the global economy still has further to fall, and will bottom out sometime during the second half of 2009. While some economies such as China, Germany, Australia, and France will likely recover; others such as the US and UK will double-dip with another leg down. “There are risks associated with exit strategies from the massive monetary and fiscal easing,” Roubini wrote. “Policy makers are damned if they do and damned if they don’t.”

Oil traded up to a 10-month high over the weekend, and carried the commodity-based currencies of Canada (CAD), Mexico (MXN), Norway (NOK), and Australia with it. Oil will continue to run up as confidence in a global recovery strengthens. Another factor that has helped boost demand for Australian dollar investments was a move by the Aussie government, which removed interest withholding tax on federal government securities. This made these investments more attractive and spurred additional demand for the currency.

The Hungarian central bank will meet today and is expected to cut their benchmark interest rate. Rates in Hungary are the highest in the European Union, and lower growth combined with low inflation will spur the cut. The Hungarian forint weakened from the strongest level in a week on the interest cut speculation.

The dollar’s role as the world’s reserve currency has been a continued topic among scholars and was undoubtedly discussed out in Jackson Hole last week. China and Russia have both been adamant about discussing the possibility of moving toward a new reserve system to replace the greenback. Since no single currency is strong enough to replace the dollar in today’s global economy, most discussion has centered around the idea of creating a ‘reserve currency’ that is comprised of a basket of the world’s largest currencies. This idea is supported by Joseph Stiglitz, a Nobel Prize winning economist and Columbia University economics professor. “The dollar’s role as a good store of value is questionable and the currency has a high degree of risk,” Stiglitz said at a conference last Friday. “There is a need for a global reserve system. The currency reserve system is in the process of fraying,” Stiglitz said. “The dollar is not a good store of value.”

Frank Trotter was thinking about the same thing as he sat and watched a musical over the weekend. Frank is a real thinker, and I really enjoy it when I get a chance to have a good economic discussion with him. Luckily for all of you Pfennig readers, he decided to send me a note on his thoughts during the performance. So here they are:

“Went to the touring musical Mary Poppins, Saturday night; it’s always great to see a play about a run on a bank. While the books were written in the 1930s and beyond, most of you will remember the Disney film set in 1910, before the Great War – when England ruled the waves and empire was returning untold dividends to the mother country. At that time, of course, there was no questioning the power, status and earning capacity of the British Empire. As George Banks replies to Admiral Boom in the movie, ‘Credit rates are moving up, up, up. And the British pound is the admiration of the world.’

“Well that was then and this is now. Soon after, in 1914, England suspended the conversion of Bank of England notes to gold for the period surrounding World War I, and the on-again/off-again slide into today’s fiat currency world began. Over the next 100 years, England has learned the lesson of empires that came before: that extending the resources of a country in non-producing capacity leads to the decline of the currency and a fall in the economic power of the country and the economic wellbeing of it’s population. In 1910 it took 4.25 pounds to buy an ounce of gold, and 0.2056 pounds to buy a US dollar. Today of course the price of gold has risen 13,447% for British buyers, while the price of a greenback is only up 195%. We are uncomfortably comfortable in feeling that the carabineers have given way for the good old USA in a parallel fashion.

“We’ll freely admit that there has been a slow motion slide going on in the US dollar since establishment, and especially since the removal from the gold standard and the Bretton Woods Agreement in 1971. But we feel even more strongly that the fiscal and monetary policies put in place starting in 2001, accelerating through the 2000s, and now amplified since January 20th, have left us with no legs for our stool. Fiscal policy has been and continues to be out of control. The Federal Reserve policy of the 2000s created the credit bubble and now stands to create the largest monetary inflation experienced in a first world nation. Both political parties have determined that no one can be an adult in government by slashing spending or raising taxes to cover our exploding gap (mathematically the only two options), and instead are hiding behind the invisible tax of currency depreciation. For a country we conclude that a strong currency is essential to long-term well being, and by extension that our government has given up on the dream in exchange for election and reelection.

“So what’s to be done? If you are a believer that the political process can sort things out and return our wonderful nation to fiscal prudence and steady governance, go ahead and stay the course. For the rest of us who like Margaret Thatcher believe that ‘the problem with socialism is that eventually you run our of other people’s money’, we’ll be letting our ‘tuppance safely invested in the bank’ seek diversification across the globe in countries and markets with more opportunity and prudence. We couldn’t agree more with the Mary Poppins conclusion, re-written for modern times that ‘Where stands the banks of [the USA], America stands. Oh, oh, oh, oh! When falls the banks of [the USA], America falls!”

Leave it to Frank to use Mary Poppins to give an economics lesson! And with that, I will close this out and head to the currency roundup.

A W-Shaped Recovery originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The data released yesterday morning was a mixed bag, as the leading indicators climbed for a fourth straight month and the Philadelphia fed reported a big jump in their gauge of activity, but the initial jobless claims unexpectedly rose. Unemployment in the US will continue to be a drag on the economy, slowing any recovery and possibly pushing the US back into recession (or as some predict a depression). Today we will get some news on the housing market, and while the media will pump up the fact that month on month sales continue to rise, another report released yesterday showed that mortgage delinquencies hit a record high in July. The proportion of homeowners delinquent on their mortgages or in foreclosure rose to its highest levels in four decades. An ominous sign for the US economy is that the problem loans have shifted away from the subprime borrowers to those driven into delinquency by unemployment. More than half the mortgages in the foreclosure process during the second quarter were prime loans. So while this morning’s data may show a bump up in monthly home sales, the US is still far from being out of the housing problems.

The European markets took the euro (EUR) higher against the dollar after reports showed German services and French manufacturing unexpectedly expanded in August. Another report showed that an index of German services industry grew for the first time in more than a year. This data confirms that the largest nation in the EU is pulling itself out of recession. The German services index rose to 54.1 from 48.1 and the French manufacturing index increased to 50.2 from July’s figure of 48.1. So both indices moved over the 50 mark, which is an indication of expansion. And the composite index of both services and manufacturing for the 16 nations sharing the euro moved to 50 from 47, another strong indication that Europe is starting to grow again.

I have read a number of articles and research reports that throw darts at the European Central bank for not being more aggressive with ‘quantitative easing’ and stimulus efforts. These latest reports indicate to me that the ECB may have played it ‘just right’. I know it won’t be clear sailing from here, and that the European recovery will still have some bumps, but the ECB left some powder dry and will be able to step in again if needed. And if the recovery sticks in Europe, the ECB won’t have nearly as much manufactured liquidity to pull in from the markets.

And I’m sure some readers will question how I can trumpet the recovery in Europe while at the same time believing that the recovery here in the US won’t have legs. The main difference is what is fueling these recoveries. While many, including your current Pfennig writer, are in the opinion that the nascent recovery here in the US has mainly been driven by government stimulus; you can’t say the recovery in Germany and France is being driven by government intervention. Digging into the recent positive data here in the US shows that the government is responsible for most of the spending; the private sector has largely stayed on the sidelines. The recovery in Europe, on the other hand, is being fueled by increased consumer confidence and internal private sector demand. In fact, many of the dollar bulls have continually chastised the European governments for not taking a more aggressive role in providing stimulus to their economies.

England and the US have yet to feel the inflationary impact of their budget busting ‘quantitative easing’ programs; but believe me, inflation is lurking just around the corner. While the US’s Bernanke and UK’s Darling have chosen to ignore the future consequences of these programs, Trichet and the ECB always kept a hawkish eye looking toward the future.

Currency traders got excited about these European data releases and took the euro back above 1.43. As Chuck would say, the big dog started to move and the rest of the pack followed suit. The leaders versus the US dollar were the Nordic currencies of Sweden (SEK), Norway (NOK), and Denmark which were 1,2, and 3 overnight versus the US dollar. Even the Swiss franc (CHF) showed some strength, matching the move up by the euro.

The Norwegian currency probably benefitted a bit from an article that ran in The Economist magazine. The article was entitled “Which central bank will raise interest rates first?” and pointed out the most likely candidates were Australia and Norway. I believe The Pfennig pointed this out a few weeks ago, but for now The Economist has a bit more readers than The Pfennig, so the article probably had a bit more of an impact on the markets. The article points to the brightening economic picture for both of these countries and the fact that “Because both countries primarily export staples like raw materials and food, their sales abroad have held up relatively well. Australia in particular benefits from Asian customers whose economies have remained pretty robust.” The magazine predicts that Norway will likely be the first to raise rates.

Long time readers of The Pfennig will recall that the direction of interest rates was at one time the largest determinant of currency movements. Those countries with central banks that were looking to raise rates were the favorite of investors. Nations with central banks who were ‘in front’ of the inflation curve and raising rates to combat future inflation were the best places to invest during this time period. Lately the currency markets have been trading on risk aversion, with bad economic news pushing investors toward the dollar, and positive news moving them back into higher yielding assets. As the global recession eases, I would look for the currency markets to return to past trends, and reward those currencies that have rising interest rates. Australia seems poised to benefit under either scenario, as they are already in the ‘higher yields’ camp and are also predicted to move these rates even higher.

No big news out of the boondoggle in Jackson Hole – not that I expect any! There was one story that caught my eye yesterday regarding the meeting. Mohamed El-Erian, the CEO of bond giant PIMCO, was on the news wires with suggestions for the central bankers meeting in Jackson Hole. He is apparently worried about the disjointed approach these central bankers have taken in their intervention with the markets and believes the approach will lead to volatile markets and slower global growth. He also believes we are in for a drop in the value of the US dollar. “The question is not whether the dollar will weaken over time, but how it will weaken,” said El-Erian. “The real risk is that you will get a disorderly decline.” According to El-Erian, the euro will rise to $1.60 by the end of 2010 and the Canadian dollar (CAD) will appreciate to 1.01.

And finally, the Mexican central bank will probably keep their interest rates unchanged at their meeting today. Inflation, which has been running above their target level, will prevent policy makers from cutting the benchmark rates to stimulate their economy. The Mexican peso (MXN) has turned in a good month, even outperforming the popular Brazilian real (BRL) and Australian dollar (AUD). But don’t get too excited, Mexico is still very dependent on a strong US market, and at least some of this appreciation has been due to rising oil prices.

Speaking of oil, crude ran through another milestone yesterday hitting the high for the year. Oil exporters such as Norway, Brazil, Mexico, and Australia should continue to benefit from these higher prices. But the other commodities we track, gold and silver, seem to be stuck in a range. Silver seems especially cheap compared to gold right now, and both are good hedges against future inflation. I have to believe both are set for a breakout on the upside at some time down the road.

Mortgage Delinquencies Move Higher originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

And what, you might asked, caused the dollar to rally yesterday? You can re-read a bit of yesterday’s Pfennig for the answer: “The data cupboard has been emptied out and is looking to get restocked today… So the only thing besides sentiment moving the markets today will be the direction of stocks…” Yes, Chuck was right in predicting what would drive the currency markets yesterday, as the dollar got sold off as stocks moved higher.

Without any data to push the markets one way or another, investors began moving back into riskier assets, selling their ‘safe haven’ US treasury holdings. The currency markets have been trading on the risk theme lately, and don’t seem ready to break this pattern anytime soon. Risk appetite is the main driver of the currency markets, with the dollar gaining with investor worries, and falling back down as investors feel more confident.

I spoke at an investment conference last week in Chicago, and listened to several good presentations on the current state of the economy. While every speaker had differing opinions on how to invest during the next few months, they all seemed to agree on one thing: the recent rally and ‘recovery’ would reverse, and the US will likely head back into another downturn. The timing of this next downturn is hard to pin down, but most believe we will see the US economy falter again toward the first quarter of 2010. If and when this occurs, the dollar could see a temporary rally as investors flee back into US treasuries. But longer term, everyone at the conference was in agreement with what Warren Buffet said in his op-ed piece yesterday: the US dollar will ultimately lose value.

Speaking of Buffet, I re-read his op-ed last night during dinner, and had to laugh a bit, as much of what he wrote could have been taken directly from the presentation I gave last week. The following lines were especially poignant, so I decided to include them in the Pfennig:

“An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually – and in combination.

“The current account deficit – dollars that we force-feed to the rest of the world and that must then be invested – will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients – China leads the list – to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

“Then take the second element of the scenario – borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

“Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.

“Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

This is what we have been preaching over the past several years, that the deficits, if unchecked, will ultimately lead the government to put the printing presses in overdrive, and we will attempt to inflate our way out of debt. This will cause the value of the US dollar to drop. Buffet ended his piece with the following line: “Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.”

Sorry to spend so much time on Warren Buffet, I know he isn’t the most popular guy with many Pfennig readers. But you can’t deny that he has been an extremely successful investor, and the piece he wrote for the NY Times was just right on in my opinion.

Lets get back to the currency markets. Good news helped propel the Norwegian krone (NOK) higher overnight. Norway’s economy grew last quarter, pushing the world’s fifth largest oil exporter out of recession. Norway’s mainland economy (ex oil and gas) was able to grow 0.3% during the second quarter. Economists had predicted that Norway’s economy would contract by the same margin. The overall economy still contracted, as oil revenues declined, but the recent move higher in crude should help keep Norway on the growth path in the second half of 2009. Petroleum exports make up a quarter of Norway’s output, so a global recovery is definitely good news for Norway. This currency, which was called the safest in the world by the NY Times, should be part of every investor’s portfolio.

The UK economy is doing quite as well as Norway’s, as Britain reported a record $13.2 billion budget deficit in July. This is the largest deficit reported for July since records began. Quarterly tax payments usually boost the revenues in July, but the recession has taken its toll on tax revenue, and unemployment benefits are pushing outlays higher. The UK is predicted to have the biggest deficit in the G20 next year according to the IMF. The pound sterling (GBP) was the largest loser versus the US dollar on the back of this reported deficit.

Minutes of the BOE’s August 6 meeting were released yesterday, and it showed that BOE Governor Mervyn King pushed for an even looser monetary policy. King pushed to expand the ‘quantitative easing’ that the BOE began in March. The pound lost more ground after the release of the report, as investors lost faith in King as an inflation fighter.

Chuck sent me this note last night and wanted me to include it in today’s Pfennig:

“I forgot all about the fact that this is that time of year again when central bankers and economists from around the world have a boondoggle at Jackson Hole Wyoming… You might recall that last year they all hunkered down and tried to think of ways to keep the financial mess from worsening, only to have Lehman Brothers collapse a few weeks later!

“Well… I’m sure we’re going to hear a lot of rhetoric about the ‘recession coming to an end’… But they have it all wrong! This isn’t a recession it’s a depression…

“With pockets of risk remaining, such as the collapsing US commercial real estate market, and the double digit unemployment rate… I would think that these guys who missed seeing the subprime meltdown coming and then when it was presented to them, told us it wouldn’t filter out into the economy… Should just keep their opinions to themselves and read newsletters like The Daily Pfennig and The Currency Capitalist, and The Daily Reckoning, and The 5-minute Forecast… OK I’ve had my say, thank you for letting me vent! Have a nice day!”

Yes, the ‘top’ economic minds (minus Chuck) will be meeting in Jackson Hole, and Ben Bernanke will undoubtedly trumpet the fact that data shows the US economy is starting to pull out of its recession. This morning we will get the index of US leading economic indicators which is projected to show a move up in July; the fourth consecutive positive monthly move. The weekly jobless claims are also expected to be a bit positive, with a fall to 550K from last week’s 558K. But the jobless rate is still projected to reach double digits (the real number has been in double digits for a while!) and housing will continue to be a drag on the economy.

The administration will also announce that the US deficit for 2009 will be slightly less than what was forecast in May. Yes, our government’s deficit will total just $1.58 trillion… About $262 billion less than the previous estimate. But the change isn’t due to increased revenue; it is mainly due to the administration’s scrapping of a $250 billion contingency plan to aid the financial industry. With the recent signs that the economy is starting to pull out of recession, the Obama administration decided it no longer needed to hold the quarter trillion dollars in reserve to meet predicted bank failures. But I would still be a bit worried if I were the administration, as there will likely be a few more ‘big’ bank failures down the road. Personal bankruptcies continue to climb, and as Chuck pointed out above, the commercial real estate market still has a few ‘surprises’ in store for the economy.

Even after this adjustment, the deficit figure would amount to 11.2% of the GDP, the largest share since 1945 when we were paying for WWII. And unfortunately, with growing outlays for Social Security, and interest on the debt eating up a larger overall percentage, the deficits won’t be shrinking in the near future.

A jump in oil prices and a reversal of risk aversion caused the South African rand (ZAR), Mexican peso (MXN), and Australian dollar (AUD) to rally. South Africa led all currencies versus the US dollar overnight, with a 0.54% appreciation. Mexico’s peso rose for a second day as oil moved back above $72 per barrel. Oil revenue funded 38% of the Mexican government’s budget last year, so the peso is somewhat linked to the price of crude. The jump in oil also helped the Canadian dollar (CAD) reverse earlier losses.

The Australian dollar rallied as risk investors moved back into higher yielding currencies, and good news in the Asian stock markets continued the rally. The Aussie dollar also benefited from the rally in oil, Australia’s fourth most valuable raw material export. The Aussie dollar is one of the best performers over the past three months, with only the New Zealand dollar (NZD) and Brazilian real (BRL) outperforming it versus the US dollar.

Stocks Push the Currencies Higher originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.