A Perfect Storm

Good day… And a Wonderful Wednesday to you! A great day yesterday, as I was able to meet up with old friends, readers, and well-wishers. So many people were just glad to see me here! I told them it was good to be seen! Looks like the oilrigs dodged a bullet with Dolly in the Gulf Coast, and that’s a good thing! But Dolly will still hit South Padre Island today; please keep that in your thoughts throughout the day…

Well… You know how on a couple of occasions in the past couple of weeks I described a Perfect Storm for the dollar? Well, those never materialized due to a number of reasons. Yesterday, we finally got that Perfect Storm, but it wasn’t for the dollar… You know those Mid-Western summer storms, when in the middle of the day, it turns pitch-black, and the trees all begin bowing from the wind, and then the rain comes down hard? Well, that’s much like what happened yesterday with the euro (EUR)… Here’s the skinny…

1. Fed Head Plosser said interest rate policy reversal “should start sooner than later”.

2. The head of the IMF said that given the medium-term fundamentals, “the euro is overvalued”.

3. U.S. Treasury Secretary Paulson, came out with he usual drum beating for the dollar, but this one sounded different… “A strong dollar is really very important to our nations’ interest and it’s something that I’ve advocated for some time.”

4. The stock jockeys swept the HUGE losses for Wachovia and Washington Mutual under the rug, and marked those financials higher! WHAT? I don’t get that one… But, there are a lot of things going on these days that don’t make sense to me!

5. Oil dropped $4…

When I got back to my room last night, I checked the currencies and they seemed to have applied a tourniquet and were moving back up versus the dollar; but this morning as I turn on the screen, I see the bias to buy dollars has been back on the table.

The commodity driven currencies of Aussie (AUD), Norway (NOK), and New Zealand (NZD) really got taken to the woodshed by the dollar, as the drop in the price of oil really led commodities down. We’ll all have to take a step back, batten down the hatches, and prepare to see some more of this bias to buy dollars, until the “jawboning” stops.

And jawboning is all the U.S. government officials have left. It’s the only arrow in their quiver, and that arrow has been used before! Recall in June, when we saw a week of jawboning and Fed rhetoric and the dollar rallied only to see it get right back to its previous levels once the jawboning died down, and the markets saw it for what it was? Well… That’s what I see for this round of jawboning… But I’ll tell you this, so listen to me now and hear me later…

The Emperor is not going to have any clothes, folks! The Federal Reserve is going to have NO CREDIBILITY if they don’t do something to match their rhetoric… And when the Fed has no credibility… WATCH OUT BELOW! But then, the Fed could regain all this credibility by coming through on their promises… But then, that would require the Fed to raise interest rates aggressively… And we all know, and they all know, and they all know that we all know, that raising interest rates aggressively will kill the goose! The economy, which is teetering, and I believe is already in recession, can NOT deal with higher interest rates…

But that’s all I have to say about that! (A little Forrest Gump for fun today!)

I know the Aussie dollar has seen a ton of selling lately… But, it’s also seeing a ton of buying too… Which leads me to believe that the selling is nothing more than profit taking. I fully expect the Aussie dollar to continue to grind higher this summer. I’ve been on record as saying that I expect the Aussie dollar to reach parity to the green/peachback. That’s my story and I’m stickin’ to it! The enduring yield advantage of the Aussie dollar is so strong that it will continue to attract foreign investment… And THAT, my friends, is the secret to currency strength in a nutshell… The ability to attract foreign investment.

The United States, on the other hand, is having a devil of a time attracting foreign investment, ever since the credit crunch hit the markets last August. I’ve told you all this before, but it bears repeating here as this is important. Foreign investors are attracted to yield differential, (and other things, but mostly yield differential), and when they wanted to invest in the United States they would seek out Corporate Bonds and Commercial Paper, as they had higher yields than stocks – which have done basically nothing for years now when you throw in inflation and Treasuries. But the credit crunch caused Corporate Bond and Commercial Paper issuance to dry up, and they haven’t recovered, even yet! And we’ve seen a huge drop in the net foreign security purchases data. I’ll repeat this later this morning in my presentation, but Pfennig Readers get it first. The total amount of the current account deficit that needs to get financed each month is $80-$85 billion. During 2007, we only averaged $51 billion, and that data kept trending downward as the year went on, and has continued to be suspect this year.

This financing of the deficit is the biggest bugaboo for the dollar… It has been, it is, and will continue to be! So… Let the jawboners talk… Let the dolts sell euros, yen (JPY), Aussie, etc. and buy dollars… Their day of reckoning will come. OK, that’s just my opinion, I have no proof that it will come; it’s just my opinion… (That will make the legal beagles happy!)

This morning, Canada printed their latest CPI (inflation) report, and it popped up again in June! CPI reached 3.1% in June, versus the 2.9% forecast. It’s more than oil prices, and the Bank of Canada (BOC) needs to nip this in the bud right now! The economy is strong enough to take a rate hike, and if the BOC wants to stop this rising inflation, they should look to raise rates immediately! If that would happen, the loonie (CAD) would certainly look to revisit parity, even if the thought of a rate hike enters the markets that would underpin the loonie.

There were two big movers versus the dollar on Tuesday… Mexican pesos (MXN) and Indian rupees (INR)… Risk taking has definitely taken over the markets folks… Risk taking…

Currencies today 7/23/08: A$ .9645, kiwi .7515, C$ .9925, euro 1.5740, sterling 2, Swiss .9670, ISK 79.55, rand 7.5435, krone 5.1480, SEK 6.0230, forint 147.80, zloty 2.0710, koruna 15.12, yen 107.60, baht 33.40, sing 1.3630, HKD 7.80, INR 42.06, China 6.8295, pesos 10.06, BRL 1.5830, dollar index 72.55, Oil $127.20, Silver $17.78, and Gold…. $934.10

That’s it for today… Well… It’s a HUGE crowd here at the Agora Vancouver Investment Symposium… Close to 1,000 people… All of whom I’ll be talking to today. WOW! The Big Boss Frank Trotter made it here last night, so it will be good to catch up with him this morning. Got to spend a few minutes with Addison Wiggin yesterday… He thanked me for writing the foreword for his book Demise of the Dollar… If you haven’t picked up your copy yet… You can still get it here! Good luck to my little buddy, Alex, as he swims in the Conference Finals tonight… I sure hope you have a Wonderful Wednesday!

Chuck Butler
July 23, 2008

The Daily Reckoning