A Two-Day Inflation Bonanza

Good day. Well, day one back from vacation was all that it was supposed to be. Crazy! Not with the currencies, mind you, but with everything else on the desk! Oh well, I made it through to today, so I’ve got that going for me, eh?

As I said above, the currencies were no great shakes yesterday, basically trading sideways, with a somewhat stronger dollar bias as we head into the two-day inflation report bonanza. You know what’s funny? I just typed bonanza, and the old TV show theme song popped into my head! I wonder how many others had that happen to them just now? Nah. I know it’s simply me!

This morning, we’ll first see PPI or wholesale inflation for July, which normally gives us an indication of what the CPI, or consumer inflation, will be, which prints tomorrow. That report tomorrow will hold the key for the rest of the week’s direction in the currencies. That is, unless a Fed Head decides to make that old mistake of opening his mouth. The old Football coach used to say, “it’s better to keep your mouth shut and let people think you are a fool, than to open it and remove all doubt.” BTW, the old Roughrider coach died this summer. I can still hear him calling me “Charlie Butler!” And as I look at the calendar, it’s August 15th, the day we would begin three-a-days.

OK. Enough reminiscing. I’ve got some more of that to do in the big finish! But for now, let’s look at these two inflation reports. First of all, you all know that I truly dislike the CPI data, for I don’t believe it’s worth a hill of beans, but the markets seem to like to focus on it, and I do like the markets. So, I have to focus on it!

Inflation is something that eats away at us everyday, and removes price stability. The government would like us to believe that consumer inflation is running at 4.2% (notice I don’t play games with removing “food and energy,” as if we don’t use those things everyday!). However, in my heart of hearts, I have to believe that if all the beans were counted correctly, consumer inflation would be above 6%.

But, let’s play along with the government here, and say, “OK, inflation is running at 4.2%. That’s 4% too much! And now, we’ve got an economy that’s slowing down and high inflation.” Hmmm. This is beginning to remind me of the mid-70s. Remember that? Stagflation? Oh, My! That couldn’t happen again, could it? I don’t doubt it.

Speaking of slowing down, the latest stuff I’ve seen on the housing market shows a general slowing down, just as the people at Toll Brothers predicted almost a year ago when they first downgraded their earnings forecasts.

So, all this steam is building up and the dollar is in the pressure cooker. The question is: When is the dollar going to feel the pressure and succumb to the heat? Well, if you look at the figures since 1971 when the dollar was removed from the Bretton Woods agreement and the gold standard, it has already succumbed. But there’s more to come, as far as I’m concerned.

You know, the emerging markets have been seen in a new light since the Fed left rates unchanged last week. Does this mean that the risk aversion that has held a grip on the emerging markets since May has ended? Hmmm. It’s hard to make that call just yet, but one could certainly make a case for an end! This would mean that currencies from Iceland, South Africa, and even Mexico stand a chance at recovering lost ground versus the dollar.

So, yesterday I was poking fun at the “boys crying wolf” again regarding a slowdown in the Chinese economy. Then, last night I saw this story and had to laugh. The World Bank has just raised their forecast for economic growth in China! All I’ll say is that nobody knows what’s going on there; for all we know China could be blowing smoke in our faces (obviously they aren’t, given the rise in base metals the last five years). Again, the old football coach’s words would work well here!

Looks like we’re seeing a fight brewing in Thailand. The Thai baht, which has gained almost 10% versus the dollar this year, saw the Central Bank of Thailand step in and attempt to apply a governor to the currency last night. That’s not a move the markets will like, so I look for the markets to hit back, and then it will become a barroom brawl between the markets and the central bank. And always, always I tell you that it’s better to look good than to feel good, my friends. No wait! I mean to say that I always tell you that the markets have far deeper pockets than a central bank, especially in Thailand!

When the dust settles on this fight, I would look for the baht to have gained more ground versus the dollar!

The two currencies that I’ve been highlighting this year, Norway and Sweden, continue to be strong versus the dollar, with Sweden outperforming Norway (+9.67% versus +6.95%). I expect this out performance to continue as I see Sweden’s Riksbank making more rate hikes than Norway’s Norges Bank. However, together these two make a powerful combo. Someone should put them together in a CD – No wait! I did! The Euro Trax takes all the “Positive Balance of Payments” countries like Norway, Sweden and Switzerland, and adds euros!

I was telling someone the other day about our MarketSafe Resource/Commodity CD, and the fellow looked at me and said, “you should have people lined up outside your door to buy that CD.” I couldn’t have said it better myself! The DJ-AIG MarketSafe CD is becoming very popular with the investment crowds.

In this whacked up, crazy world we live in these days – where a currency is rewarded for having inflation and sold when inflation begins to come under control – we have the British pound sterling. Now, sterling has had a great comeback year in 2006, gaining back 9.5% of lost ground to the dollar in 2005. And most of that gain has been fueled by the fact that the United Kingdom’s economy was strong, and inflation was running stronger than the Bank of England’s target.

However, this morning I see a story running across the screen that says, “Pound Drops as U.K. Consumer Prices Decline in July from June.” See what I mean? Crazy! Hey! That gives me an idea (Uh-oh, I hear you saying). Here is the market’s new theme song: I’m crazy for trying, I’m crazy for crying, and I’m crazy for thinking that inflation is good for a currency. If you sing it like Patsy Cline you’ll have more fun with it!

Currencies today: A$ .7615, kiwi .6315, C$ .8845, euro 1.2730, sterling 1.8880, Swiss .8050, ISK 71, rand 6.8880, krone 6.30, SEK 7.2350, forint 216.45, zloty 3.05, koruna 22, yen 116.50, baht 37.45, sing 1.58, INR 46.40, China 8.00, pesos 10.87, dollar index 85.61, silver $12.04, and gold $626.40

That’s it for today. Now for the reminiscing! When I returned from vacation, I was saddened to hear that Adam Aronson, the former chairman of Mark Twain Bank, where all this currency stuff began, had passed away. Adam once shared a Snickers bar with me, and told me not to worry about being overweight, as long as I was comfortable with who I was. He recruited the best and brightest, as we used to call them. But if you look around the St. Louis banking scene, you’ll find most of the men and women he recruited running the banks! Our own big boss, Frank Trotter, was one of those best and brightest, and is the perfect example of what I mean by “best and brightest!”

Adam changed the way banks operated and worked with consumers. However, the stories could go on for a long time, and I don’t have the time or space to go into them. I was at Mark Twain Bank for 17 years before they sold out, so I have many stories. Anyway, he’ll be missed.

Have a great Tuesday!

Chuck Butler
August 15, 2006

The Daily Reckoning