GDP Goes Negative

Good day… And a Happy Friday to one and all! A Happy Halloween Friday to boot! Boy, to be a kid again, and have what is forecast as a 70-degree day on a Friday for Halloween! We’ve been so busy at the Butler house that we didn’t even decorate our front yard with Halloween stuff this year. UGH! But, that’s OK, I guess. Alex is older now, and little Delaney Grace would probably freak out at the ghost that would fly across the front of our house, etc.

Well… The fog that was lifted from the markets came back with a vengeance yesterday, and once again it was the deep, dark, dangerous U.S. economy leading the charge. Third quarter GDP printed yesterday and even though it was forecast to be negative – when it actually printed negative – the trading theme returned. Third quarter GDP goes negative (and if you throw in inflation for good measure, growth was REALLY negative!) and the dollar rallies… It’s the trading theme of the decade! (OK, I exaggerate a bit there, as it has only been in place for three months now!)

And get this… Recall how second quarter GDP (+2.9%) was goosed by net exports (because the dollar was weak)? Well… Apparently the dollar was still considered “weak” during the third quarter because net exports added 1.3% to GDP in the third quarter! I can’t imagine what the fourth quarter GDP number will look like… Well, actually I can… And the big fat red figure doesn’t look pretty! Anyway, what I was trying to get at before my fat fingers started typing something else, is that fourth quarter GDP isn’t going to get any goose from exports, given the strength of the dollar these days!

So… As I left you yesterday, the euro (EUR) had “gapped up” to 1.3145, and the stars were getting in alignment, the karma was flowing, and peasants were dancing in the streets, as the things seemed to be getting back (somewhat) to normal, and the fundamentals were back on the table. But, then the third quarter GDP print brought the deep, dark, dangerous clouds/fog back over the markets, and the trading theme kicked into place, with the dollar rallying and pushing the euro to 1.27! That’s some strong volatility there, folks… And as I said the other day, something I’ve not witnessed before… Yes, there was volatility in currencies, but not like these wild swings we see on a daily basis now. The “trading crowd” has to be pulling their hair out, as I think about how they put on trades and then add “trailing stops” at a certain percentage away from the current market. With these wild swings, they have to be seeing their trades “stopped out” almost instantly!

I have nothing against the “trading crowd”, it’s just like stocks, commodities, etc. Me? I’m a diversification kind of guy… I don’t have the stomach for “trading”. I would probably be taking as many losses as gains and it would all be fruitless anyway!

OK… The currencies, Chuck, focus… Concentrate… OK, I’m back now. And one more point on the third quarter GDP print… It appears as though the U.S. consumer is in full retreat.

About a year ago, I gave a rousing speech in New Orleans (well I talked anyway!) and painted an ugly picture for the U.S. dollar with regards to borrowing needs to finance the debt going forward. Well, that was all playing out until the credit squeeze took control of the markets in July. But that doesn’t mean the funding needs of the United States are going by the wayside… A reader sent me a note to look at a story he saw with regards to the debt and borrowing needs. Here’s a snippet of the Bloomberg story…

“The U.S. government’s borrowing needs will almost double to $2 trillion this fiscal year, prompting the Treasury to revive three-year notes and hold more frequent sales of 10- and 30-year debt, according to Goldman Sachs Group Inc.”

Then, I read The Daily Reckoning and saw where friend, Dan Denning, had this to say… “The 30-year Treasury bond yield plunged 27 basis points last week to 4.062 percent. It reached 3.8676 percent on Oct. 24, the lowest since regular issuance of the security began in 1977.

“This is the last big bubble. There’s going to be a stiff penalty for staying in Treasuries as the supply increases (the three-year note is coming back, monthly auctions for ten-year notes will resume). Plus, you know, all that new stimulus. All that new borrowing.

“Yields will be going up for sure…”

Hmmm… Debt… Treasury issuance… And we have only just begun… (No I’m not going to do The Carpenters here…) I’m talking about the problems of giving 70 million baby boomers what they will be looking for as they begin to retire. (The first baby boomer began receiving Social Security this year!) You know who can give you all the facts you need about the amount of debt that will be added to the U.S.’s ledger as each year goes by and more baby boomers (like me) retire (not me yet!)? His name is David Walker… And he is the former U.S. Comptroller General – and if anyone should know, it’s him!

Well, David Walker is a central figure in both the book and the film I.O.U.S.A. He resigned from his job to take a position with the Peterson Group and spread the word about a coming crisis in the United States with regards to debt burden. (If he were able to tell the truth about it, he would probably say he left his job because no one would listen to him (recall the deficits don’t matter crowd!), and he wanted to do something about the problem!) And David Walker is telling everyone who will listen that we (as a country) need to act now if we want to keep the United States from going bankrupt… There’s a snippet of the I.O.U.S.A. book in Forbes this month that was carried by MSN Money…

OK, anyway… What does this all have to do with currencies you’re asking? Well, grasshopper… Sit, and listen… Not that this is the case right here and now, but every year we get closer and closer to having to pay interest on debt obligations out our ears! And there will come a time when we won’t even be able collect enough taxes to pay off our obligations… So… You can rest assured that 1. Taxes are going to have to go higher and higher and higher… And 2. The government will allow the dollar to weaken and weaken and weaken, so that they can pay back the interest and debt with CHEAPER DOLLARS!

But for now… The dollar is in a bear market rally, which gives a lot of people that missed one of my 150 talks over the past eight years and who didn’t know they could be diversifying out of the dollar as a hedge, a chance to get in at prices that aren’t at all-time highs! Is this the bottom and the best prices they’ll see? I don’t know… My crystal ball is pretty hazy these days, but what I do know is that these prices are bargain prices versus what was seen in June, just four months ago.

Today, we’ll see the color of the September Personal Income and Spending reports… I fully expect to see the tide change on these two. I expect to see Personal Spending go negative, thus showing that we didn’t spend more than we made, which will be a major shift change in this trend. Don’t look for any big gains in Personal Income either, though.

We’ll also see the Employment Cost Index, which used to be a closely watched piece of data, by the Fed… And finally the Chicago Purchasing Manager Index (manufacturing), which will probably be awful… So… Once again, the data doesn’t help things any. The rot on the vine is quite evident.

But, then too is the rot on the vine over in Europe. A month ago, we were all led to believe that they were going to get to Ollie, Ollie, Oxen Free on the toxic waste bonds, only to have that blow up in their faces. And now the emerging markets of Eastern Europe are dragging the European Union down… But they’re still putting on a brave face at this point.

Speaking of the European Union… The European Central Bank (ECB) will meet next week, and I think we’ll see them cut rates to keep in step with the Fed, but I think they will be kicking and screaming all the way to the rate cut table. The ECB has a mandate from the Maastricht Treaty that requires them to provide price stability… Now, that will be difficult to achieve when they are cutting rates and debasing the currency… But, it’s the call to arms right now, with the U.S. Fed calling the shots on rate cuts.

Shoot Rudy, even the Bank of Japan (BOJ) cut rates last night. I had thought earlier in the week that the BOJ was just jawboning the yen (JPY) weaker with that kind of talk… But, they were able to squeeze another drop of blood out of the turnip and cut rates 25 BPS. That erases the 25 BPS rate hike they made a year or so ago, and led everyone to believe they were breaking out of their decade of deflation.

The rate cut didn’t hurt the yen as much as the talk the other day, so for yen it was a case of sell the rumor buy the fact… I would think that with all the dark clouds forming over the United States once again, the risk takers would be running for shelter once again, thus pushing yen stronger, but that remains to be seen as of right now.

Currencies today 10/31/08: A$ .6650, kiwi .5830, C$ .8180, euro 1.2760, sterling 1.6230, Swiss .87, ISK (still no quote), rand 10.0675, krone 6.6980, SEK 7.7850, forint 204.50, zloty 2.8380, koruna 18.91, yen 97.90, baht 35, sing 1.4835, HKD 7.7890, INR 49.45, China 6.8380, pesos 12.74, BRL 2.10, dollar index 85.54, Oil $63.85, Silver $9.45, and Gold… $727.30

That’s it for today… Can’t wait to see my darling granddaughter today dressed up in her bumblebee costume! And I can’t wait to see the kids in the neighborhood in their costumes tonight. And the terrible jokes they come up with… They’re funny anyway! Last night was a late one, as we had our Art Show here… A good time was had by all. I got to catch up with a lot of former Mark Twain Bank colleagues… I don’t know how Frank Trotter does it, but he somehow keeps in touch with all those folks that are spread out all over town! My beloved Missouri Tigers travel to Texas again this week to play Baylor. It won’t be easy, but I have full faith in these Tigers to win! Next Saturday, I travel to Columbia again, and hope this time will be different from my last trip there to see the Tigers play! And my little buddy Alex has his last football game of the year tomorrow. He does love to play football! That’s it… I hope you have a Happy Halloween, and a Fantastico Friday!

Chuck Butler — October 31, 2008