China to Buy Spanish Debt. Euro Rallies.

Well… It’s a “risk off” day that began yesterday afternoon… The only strange part of this risk off trading is the fact that the euro (EUR) is rallying versus the dollar! I know, I know, that seems to be a very strange occurrence… But it’s true, it’s true, I did see a euro rally! Other than euros, and sterling (GBP), the rest of the currencies have taken on water versus the dollar since yesterday afternoon, and that includes gold and silver, which have sold off too.

The biggest reversal has come from the Aussie dollar (AUD), which yesterday morning was $1.02 and change, and this morning is trading at less than $1.01… The selling in the risk assets led by Aussie dollars began yesterday when, for some reason, the markets began to question China’s economy again… What? Questioning China again? How many times does this make that these guys have thrown China’s economy under the bus – and caused a huge sell off in the commodity currencies – only to see that they were wrong, which then forces us to deal with the weaker commodity currencies? Too many to count, that’s the answer! Too many to count! And it’s giving me a rash! Geez Louise! Give it up, will you?

The Aussie dollar is also seeing some weakness with all the flooding going on in the country. First, Australia had to deal with droughts, and now floods… But… If the past – since 2003, when the first calls for a collapse of the Chinese economy hit the news in the USA Today – is to be repeated, then…we should use this opportunity to buy at cheaper levels, for in the past, that would have been a very wise thing to do, given the eventual results.

The coldest December since 1969 caused Germany to post its first rise in unemployment since June of 2009. Hmmm…. Well, that explains why the euro has rallied this morning, now doesn’t it? NOT! Makes no sense whatsoever! But, don’t let that get in the way of a euro rally, eh?

Pound sterling is the best performing currency overnight and throughout the European session this morning. The UK has seen better results from recent data prints, and their inflation is rising, which should be a warning signal to us here in the US, because since 2008, whatever happens in the UK eventually ends up happening here! So, the pound sterling has been able to gain some ground… But I’m not sold on the pound, and wouldn’t be going out and buying up a basket full of pound sterling… Things are too dicey in the UK for my tastes.

The BIG news this morning is that China has announced that they will buy Spanish debt… The Chinese Vice Premier said, “China has confidence in Spain’s financial market. It has purchased Spanish Treasury bonds and will buy still more.” And, you’ve got to think that this is the news that has pushed the euro higher this morning.

The Big Boss, Frank Trotter, and yours truly, were talking a couple of weeks ago, and we agreed that the prudent thing for China to do would be to buy as much Eurozone periphery country debt they can get their hands on… and not because we want to see the Eurozone supported by the Chinese. It was from a Chinese viewpoint… They already own a ton of US debt… Why not own a ton of Eurozone debt too? I think you see where this is going… The Chinese could become the world’s creditor. Remember when the US was the world’s creditor? Imagine that scenario for the Chinese.

2011 should be an interesting year for the Brazilian real (BRL)… The new President has vowed to deal with the strength of the currency, which she blames for racking up a record deficit for the country… But on the other side of the coin, you’ll have the central bank, which needs to raise interest rates. Recall, I told you a few weeks ago that inflation was rising in Brazil, and the central bank needed to raise interest rates? Well… I’m now seeing reports from Brazil that say that interest rates could be going up as much as 1.25% this year… Now, let’s see what the new President can do to offset the flow of investments, when the central bank turns the rate hike spigot on! Memo to the new Brazilian President… LEAVE THE CURRENCY ALONE, AND FOCUS ON OTHER MORE IMPORTANT THINGS…

Did you see that the “euro club” has a new member? Estonia has joined the “euro club” bringing the number of countries in the fold to 17. I see this as questionable, but apparently they met the criteria… And if you meet that criteria honestly (not like Italy and Greece met it) then you’ve got your ducks in a row.

And did you hear this one… The White House is social messaging their renminbi comments now? Yes, Twitter messaging about China needing to do something about their currency (CNY) and trade, is now going on by White House spokesman, Robert Gibbs… And wouldn’t you know it? China’s President, Hu, is going to be visiting the White House later this month… Hmmm… Consider this the hint of the century… The White House is going to pressure President Hu once again… I hope he tells anyone putting pressure on him to take care of their own house!

Then there was this… From The Economist

That leads to another potential flashpoint for 2011: the lack of global co-ordination. Gone is the consensus seen at the G20 meeting in April 2009. Europe will be pursuing austerity, China is trying to rein in bank lending but America has opted for another fiscal stimulus. This is a throwback to pre-crisis 2007, with American deficit-financed consumption set against Chinese surplus-creating exports.

It seems certain that the Federal Reserve will continue to accompany fiscal stimulus with the monetary equivalent in the form of near-zero interest rates and further quantitative easing. The need for such extraordinary measures is an indication of how weak the economy continues to be. But while the developed world is still fighting off deflation, the developing world is worrying about inflationary pressures, with gold near $1,400 an ounce and oil back above $90 a barrel.

But it is quite possible that the dollar could suffer another round of weakness in the coming year. After all, the currency has no yield support, a continuing trade deficit and the prospect of endless fiscal deficits. The sorry condition of municipal and state finances could yet be the trigger for a loss of confidence.

This list of problems is the reason why it is so hard for Buttonwood to join the bullish consensus for 2011. The authorities have kept the plates spinning by dint of an enormous effort and some unprecedented monetary measures. But the underlying problems have not been solved. And the law of gravity cannot be suspended forever.

To recap… It’s a “risk off” day for the currencies and precious metals, as China’s economic strength is being questioned once again. The two bright lights in this dollar rally are the euro and pound sterling. The euro getting its support from news that China will continue to buy Spanish debt, and the pound sterling is getting its support from stronger economic data, and rising inflation, which leads some to believe that the Bank of England will be entertaining thoughts of rate hikes soon… (Although I doubt it)…

Chuck Butler
for The Daily Reckoning

The Daily Reckoning