An Unhappy Ending

Good day… And a happy Monday! Well… I’m back! I’m still not in my saddle at work, but I am ready to take back my newsletter that I started in 1992! Before I go on, I can’t even begin to start without a HUGE THANK YOU to Chris Gaffney for picking up the ball for me while I have been in and out of the hospital and recovering! Chris did a GREAT JOB, and I know that as I go forward in my battle with cancer I will lean on him many times to fill in for me again, and every time, I know, that the Pfennig will be in good hands!

Chris signed up to fill in for me whenever I went on vacation and on the road… But not for over two months! So… Again… THANK YOU CHRIS!

OK… I am fired up to write the Pfennig in whole today… But I have to tell you I just don’t have good news for us U.S. investors. I’m going to spend a lot of time at the beginning talking about the subprime meltdown and what’s going on. Get ready, strap yourself in, this is scary stuff!

Before I get started on the scary stuff, I should tell you that the there was a bias to buy dollars on Friday… But as I will explain in the following paragraphs, I just don’t see this continuing much longer.

OK… First of all let me start with something I read in my friend John Mauldin’s weekly email on Friday…

“In the early fall of 1998, I remember being on a flight to Bermuda from New York. I was upgraded and sat next to a very distinguished looking gentleman. He was going to a conference about re-insurance and I was going to speak at a large hedge fund conference. We hit it off, and began a very interesting conversation, one that still burns in my mind today. It turns out that he was vice-chairman of one of the largest insurance firms in the world, and was a real financial insider, seemingly knowing every big name on Wall Street personally. After he had a few drinks (he was clearly somewhat stressed), he began to talk about the Long Term Capital Management fund and the problems in the markets. He had had a ringside seat at the Fed-sponsored bailout proceedings.

“‘We came to the edge of the abyss in the financial markets this week,’ he told me, ‘and then we looked over. The world does not understand how close we came to a total meltdown of the markets.'”

So… Does this current need for liquidity as supplied from the Fed, the ECB and other Central Banks mirror 1998 or even come close?

Well… As most of you know I truly admire the work of economist Nouriel Roubini… And here’s what he had to say about this…

“As in 1998 at the time of the LTCM crisis,” writes Nouriel Roubini on his blog this morning, “the Fed and global central banks decided to ease monetary policy in between meetings and injected a large amount of liquidity into the system.

“Two days after the Fed tried to signal in its FOMC statement they wouldn’t bail out of the financial system, ‘The Fed actions today are certainly ironic. The current market turmoil is much worse than the liquidity crisis experienced by the U.S. and the global economy in the 1998 LTCM episode.'”

And… Why is this all happening? Well… I turn to this story and quote to explain…

“Analyst Matthew Rothman of Lehman Brothers wrote that the models are working in exactly the opposite way they should to protect a black box fund in an up or down market. ‘It is not just that most factors are not working but rather they are working in a perverse manner.'”

What he’s talking about here are the computer/black box models that were programmed to supposedly figure out all the security movements, and how they didn’t count on this current situation.

What really gives me a horrible rash is the fact that just a couple of weeks ago Treasury Secretary Paulson and Fed Chairman Bernanke were telling us that the subprime mess wouldn’t be a big deal. And you know me… I’ve been beating a drum for people to protect themselves from this meltdown for months now!

I would like to know what Big Ben says now, that he had to inject billions in liquidity to offset a credit crunch created by the subprime meltdown!

On Friday, it was reported that the SEC was now examining major Wall Street Banks to determine their vulnerability to home-loan defaults. Uh-Oh… No hiding them under the rug, eh Big Boys?

So far, the dollar hasn’t seen the problems that are ahead of it… But it will. It’s just a matter of time! As Chris explained on Friday, U.S. Treasuries are still seen as a “safe haven” place to park funds when things in the world look scary. Never mind the fact that the U.S. mortgage lenders and people that lied on their applications created this mess. Right here in the good ‘ol U.S.A.!

That brings me to Chinese “nuclear put” that I talked about last week. China did their best spin-doctors job of trying to dispute the story that they would look to sell U.S. Treasuries in response to U.S. lawmakers placing tariffs on Chinese exports to the United States. But that brings something to me… This back and forth between the U.S. and China can only turn up bad in the end for the United States. Bringing about an unhappy ending for the United States and the dollar!

So, while China has backed off for now, I wouldn’t be surprised to see them bring this up again in the future… Or when any other knucklehead lawmaker suggests a tariff on Chinese exports!

That brings us to the rate picture around the world. Some time ago I said that Norway’s Norges Bank would raise rates in August. But can they do so now with all this going on? And how about the European Central Bank (ECB), can they deliver what was once believed by me as a done deal rate hike in September with all this emergency cash being injected into the markets? The answer to these and many other questions can be seen at the bottom of this cereal box!

No, seriously… I think the answers are no, and no. However, for the ECB they have to realize that the injection of all this money supply is going to eventually raise inflation. Oh, and it looks like the ECB injected another $65 billion this morning. Now, there’s something for your coffee!

So, as I look out on the currency horizon… I see that there’s still a bias to buy dollars this morning… Why? Ah riddle me this Batman! That’s how confusing this all is. Or as Chris said on Friday, “dollar buying is counterintuitive”.

OK… Data wise today, we only get retail sales for July. Basically, I really got a taste of the Butler Household Index (BHI), since I was stationary at home during the month! The BHI tells me retail sales will be stronger than June’s dismal showing. But still, not the stuff that economic recoveries are made of! So, the dollar shouldn’t get much love from this piece of data today.

Tomorrow we will see the color of the latest trade deficit, and backing that up, on Wednesday we will see the latest TIC (security flows) data. This data has become so important again… So it will be interesting to see how we fared!

Wednesday also has the stupid CPI (consumer inflation), industrial production and one of my faves, capacity utilization, neither of which will be strong or weak enough to move the currencies.

Last week I wrote about commodities… And a quick look at the CRB Index tells me they didn’t have a great week… UGH! Oil is down, which is good… And gold is up, which is good! So, those two offset each other in the index. The base metals must be selling again. Sort of like the people on the bus… They go up and down!

Usually though, they go down and then bounce. So I’m waiting for the bounce! While I’m waiting, I’m looking for bargain basement currency levels. Aussie (AUD) sure looks like one… As does Japanese yen (JPY), still!

But how about that Japanese yen? It has been stuck in the middle of the tug-o-war going on in the markets between “the carry trade is over” and “the carry trade is not over crowds”… But, it sure looks better at 118 than 125 where it was headed when I left the office two months ago!

Ok… I’ve written enough for one day… Especially my first “full day” back on the Pfennig! So, I’ll head to the Big Finish here, and then go back to sleep! HA!

Currencies today: A$ .8445, kiwi .7385, C$ .9485, euro 1.3655, sterling 2.0130, Swiss .8335, ISK 65.60, rand 7.18, krone 5.8480, SEK 6.8230, forint 185, zloty 2.7675, koruna 20.5350, yen 118.10, baht 31.50, sing 1.52, HKD 7.8230, INR 40.60, China 7.5810, pesos 11, (no dollar index today) Silver $12.88, and Gold… $681.20

That’s it for today… Coming live to you from the Butler home today! This will be the arrangement until I return to the office… It won’t be long, now… Barring any setbacks! I had a great time at the ball game on Friday, as I got to see most of my friends from the office, most for the first time in two months! Delaney Grace made a visit to see me on Saturday. Man! She’s a cutie! Sorry to start the Pfennig off with such “downer” news… But that’s what’s going on… No reason to ignore it! Have a great Monday and week, I’ll talk to you tomorrow!

Chuck Butler
August 13, 2007

The Daily Reckoning