Allowing the Dollar to Weaken

The non-dollar currencies are back on the rally tracks versus the dollar this morning, after giving back some ground on Friday. The story that I brought to you on Thursday morning, about central banks diversifying, is really going around the block. In case you forgot, the gist of the story was that central banks added to their currency reserves in the last quarter, and had put 63% of that new cash into euros and yen. For those of you keeping score at home, that’s more than $80 billion in one quarter!

No wonder, the euro (EUR) and yen (JPY) were taking liberties with the dollar in April, May and June… Of course, these two have continued taking liberties with the dollar in July, August and September, but we won’t get the currency reserves data for another three months! But we all know what happened, and what has happened since March first of this year. Round and round we go, where we stop nobody knows!

Well… That is short-term wise, and over the years, short-term prognostications for currencies have proven to be very difficult to get right… Long-term? Well, currencies for the most part, make long sweeping moves… And this long sweeping move by the dollar downward is being aided by the US government! That’s right, the US government has shown a willingness to allow the dollar to weaken. Oh yes, they carry on about a “strong dollar policy” and all that, but they don’t back it up one iota… And, when we get down and dirty regarding US dollar policy, it is my opinion, that the government sees no way out… That the only chance they have to pay back debts, is with a cheaper dollar. That’s it in a nutshell… The government wants, and needs a cheaper dollar.

However, they don’t want it overnight! They don’t need it overnight! The debts aren’t due right now… So, that’s why you see them spit out stupid statements about a strong dollar policy, they all know that that’s not what they really want, but they can’t be seen as not willing to defend the dollar.

It’s all there in front of you… The deficit spending, the quantitative easing, the bailouts, the stimulus, the zero rate interest policy, the corporate scandals that go unchecked leaving foreign investors weary about their investments… And on and on and on… And then there’s this little ditty, which should give you all the information you need to make the decision to diversify a portion of your investment portfolio out of the dollar. THE US WANTS CHINA TO ALLOW THEIR CURRENCY TO GAIN VS THE DOLLAR!

When lawmakers, central bankers, and US Treasury Secretaries all go to China year after year, and beg, and plead, and whine, to the Chinese authorities that the renminbi (CNY) needs to get stronger versus the dollar, what’s a currency investor supposed to think? That’s right, that the US wants a weaker dollar… Period.

Oh! And one more thing that’s really scaring the bejeebers out of foreign investors – including central banks – is the fact that the US has this enormous national debt, and doesn’t seem to care. US lawmakers are oblivious to the deficit… In fact, they continue to look for new ways to deficit spend! UGH! This stuff just gets me going, folks… If you could be here to see me pounding on the keys, shaking my head, and yelling at the wall, you might think I had gone crazy… Well, not as crazy as spending when we don’t have it!

Last week, we had the former Fed Chairman, and the man I believe is at the roots of this whole financial mess we’re in, Big Al Greenspan, talking about the economy, and the growth prospects, and what have you. I have no idea why anyone would listen to this guy… If you read Bill Fleckenstein’s book on the Fed – Ignorance at the Federal Reserve… Greenspan’s Bubbles – you’d see Big Al’s track record of wrong decisions, which go back to his days before becoming a Fed Head. Well… Ty sent me a note from James Kunstler’s newsletter, where he jumped all over the Greenspan comments last week… This is a snippet of what James Kunstler had to say…

“Greenspan’s greatest success may be to drive economics into such disrepute that it will be cut loose from the universities and only be taught by mail order or internet subscription from the same outfits that offer PhDs in astrology.”

Now that’s funny!

Alright then… Let’s take a look around the horn, and see what’s moving this morning. As I told you, the non-dollar currencies were back on the rally tracks versus the dollar this morning, and so, the Big Dog (euro) is moving higher, along with the Aussie dollar (AUD), Canadian dollar/loonie (CAD), and Norwegian krone (NOK)…

Let’s take the euro… Last week, The European Central Bank (ECB) met, and left rates unchanged, as suspected, and the risks were with ECB President, Trichet, after the meeting… When asked about the euro’s strength, he simply repeated his statement from the previous meeting… Something about, the need for US dollar strength… But nothing new… I think his non-new statement was an indication that he’s not willing to fight for dollar strength any more than he has, if the US is not going to step in and join the fight! Memo to Trichet… You had better figure out who’s going to be in that foxhole with you before you jump in! Bernanke? Geithner? YIKES!

The Aussie dollar continues to push the envelope of strength that a currency can gain by raising interest rates 25 BPS! I knew in my heart of hearts that a rate hike would underpin the Aussie dollar, but didn’t think it would be as beneficial as it has been… But then, maybe the thought that I shared with you last week, is gaining some credence… That with the latest employment report showing such strength, the Reserve Bank of Australia (RBA) would be back in November for another rate hike of 25 BPS!

The interest rate differentials just keep widening to the dollar, folks… And while, as I always say, interest rate differentials are the “end all” of currency valuation, it does go a long way toward attracting investment, and attracting investment goes a long way toward currency valuation!

And while Canada certainly doesn’t have a rate differential to the dollar, it does have the commodities associated with energy… Oil, natural gas, and coal… If the prices of those commodities begin to rise it won’t be long before we see the Bank of Canada (BOC) hike rates, whether the economy is ready for the rate hikes or not! And that thought has lit a fire under the loonie recently.

And finally, the Norwegian krone… Norway’s central bank, The Norges Bank, resisted cutting rates to the bone, and while they never did get as low as the US and Canada, they did get pretty low… But, remain higher than those in the US and as I’ve said over and over again in the past couple of months, the Norges Bank will raise rates in 2009, so. That means the rate differential will widen. And again, being forward looking, the currency markets’ participants have taken the krone higher versus the dollar.

On the data front… Friday, the trade deficit narrowed for the first time in a couple of months… The thought is that the cheaper dollar during August, was the main reason for exports outpacing imports… While, a cheaper dollar won’t cure the trade deficit completely, it certainly can put a major dent into it… So, here’s another reason the US government would love to see a weaker dollar! Talk about “killing the golden goose”! If the US government were to talk up the dollar, it could very well, kill that “golden exports” goose!

We’re still waiting for the budget statement to print, folks. I’m always of the thought that the longer you have to wait for a piece of data to print, the more it’s getting cooked, massaged, “adjusted”…

Wednesday this week, we’ll see retail sales for September… The Butler Household Index (BHI) tells me that retail sales will be OK… Not negative, but OK… Not strong, but OK…

Chris will bring you the results of the retail sales data along with the other data due this week…

So, to recap… The currencies are stronger this morning, with the euro leading the charge versus the dollar. The central banks’ diversification story that I told you about last Thursday, is really getting around the block, and causing dollar weakness. We went over the reasons for this diversification, and the willingness of the US to just ignore their deficit, and spend more! Aussie, Norway, Canada’s respective currencies join the euro with gains of their own versus the dollar… And… How the US doesn’t want to kill the golden goose… You’ll have to read the entire report to get the details!

The Daily Reckoning