Don't Trust the Dollar Strength

As predicted, both the European Central Bank and the Bank of England kept their benchmark interest rates at record lows in an effort to keep stimulating their economies. Trichet signaled that the ECB has no plans to raise rates in the near future, stating that the current level is ‘appropriate’ for the current economic environment. “The recovery is expected to be rather uneven,” Trichet said. “It will be supported in the short term by temporary factors but will be hampered in the medium term by balance sheet issues at financial and non-financial institutions.”

When asked about the recent fall of the US dollar, and the possibility of currency intervention, Trichet repeated the standard line saying, “excess volatility and disorderly movements” hurt growth; and policy makers “will continue to monitor the exchange markets closely and cooperate as appropriate”. Trichet also stated that he trusts his US counterparts (big mistake!) as to their statement on the strong-dollar policy. “When the Secretary of the Treasury and our friend Ben Bernanke say that a strong dollar is in the interests of the US economy and that they are pushing a strong dollar policy, this is a judgment that is obviously very important for us and the global economy.” NOTE TO TRICHET: YOU CAN’T TRUST A CHEATER!!

The current administration may say they support a strong dollar, but their actions sure don’t show it. Quantitative easing efforts have pumped a record amount of liquidity into the markets, and Washington has the printing presses working overtime. Unless the laws of supply and demand have changed, all of these US dollars that have been created will cause the value of the dollar to drop. We have seen a 15% drop in the value of the dollar index in the past six months. The current administration has no reason to support a strong dollar, and realize there is no way they are going to be able to protect the value of the dollar while pursuing their ‘quantitative easing’ policies. In order to protect the dollar, Geithner and Bernanke would need to shut off the printing presses, and actually put them in reverse, pulling liquidity out of the markets. There is absolutely no way this will occur anytime soon.

The Bank of England also left rates unchanged and announced that they would continue to push money directly into the economy through purchases of government and corporate bonds. At least one of the policy makers in England seems to understand what is going on. Conservative leader David Cameron stated today that the policy will lead to inflation, signaling to his party’s annual conference that it would stop the government’s main economic stimulus program if it wins the next election. “Sometime soon that will have to stop because in the end printing money leads to inflation”, Cameron said. But others remain trapped in their own twisted reality with former BOE officials calling Cameron’s remarks ‘dangerous’.

The dollar moved up a bit versus the euro (EUR) and pound (GBP) after the announcement, but fell again overnight. Overall, the greenback is up compared with yesterday morning, with the biggest moves coming against the New Zealand dollar (NZD) and Japanese yen (JPY). Asian central banks intervened heavily in the currency markets on Thursday to help support the US dollar. With China keeping the renminbi (CNY) stable versus the US dollar, other Asian currencies not pegged to the falling dollar have risen. Governments in Japan, Thailand, Hong Kong, and Singapore were big buyers of US dollar yesterday and continued with their purchases overnight. And while their efforts may work to slow the dollar’s decent, it won’t change the direction. These central banks just don’t have the financial power to change the inevitable fall of the US dollar.

Data released yesterday showed that initial jobless claims in the US fell slightly to 521K, and that continuing claims also drifted lower. Both are still near historic levels, and don’t support the claims that the US economy is pulling itself out of the recession/depression.

In other news, chain store sales managed to eke out a small increase in September. While the news caused a rally on Wall Street, the YOY increase was mainly because the stores had absolutely abysmal sales one year ago. The largest industry group is cautioning against reading too much into the increase, and to continue to predict a decline in sales for November and December.

In another report, the Commerce Department said wholesale inventories fell 1.3% in August, worse than the 1% drop economists had expected. This follows a 1.6% drop in July, as businesses continue to reduce inventories.

Today we only have one piece of data, the trade balance, which is expected to show a deficit of $33 billion for August. This deficit comes in spite of a falling US dollar, which should eventually make our exports more competitive, and force a narrowing of this balance. The continued deficit forces the US to have to attract foreign capital as imports continue to outpace exports.

Canada got a good piece of news yesterday as Canadian employers added jobs for the second straight month in September. The unemployment rate fell to 8.4% as employment rose by 30,600. The report will increase pressure on the Bank of Canada to raise interest rates from record lows, and could lead to strength in the Canadian dollar (CAD). We have been supporters of commodity based currencies, and Canada certainly has an abundance of raw materials. Their proximity to the US has caused some concern, as the US is still their largest trading partner, but Canada has worked to strengthen ties to China and is now enjoying an increase in exports to Asia as the recovery takes hold in the Far East.

An associate from headquarters down in Jacksonville emailed me last night to ask my opinion on recent events in Latvia. Now I certainly try to stay informed on all of the countries around the globe, but had to be honest and tell him I haven’t really ever looked at what is going on in Latvia. But after doing a bit of research, I realized what had sparked the question. Economic troubles in the Baltic state led to concern over the future health of Swedish banks. Plunging property values in Latvia have left borrowers ‘upside down’ on their mortgage loans, which are mainly provided by Swedish banks. The Latvian government had announced a plan to protect homeowners from foreclosure, angering Sweden. But overnight, Latvia has announced it is pulling away from its earlier plan, and would come to an agreement with its international lenders. It looks as if the ‘Latvian’ crisis will be resolved, and Swedish banks will avoid the possible losses that could have occurred. The Swedish krona (SEK) is unchanged on the month, and has increased over 12% in the past three months. With the Latvian crisis avoided, the krona will likely resume its move higher versus the US dollar.

After hitting an all-time high yesterday, gold slipped back slightly overnight. This was the first drop in the gold price this week, after the biggest weekly advance since April. We had expected a pause in the rapid ascent for gold, and a small move higher by the US dollar has pushed gold lower. Many traders are now calling for a near-term correction in the price as investors take profits from the rapid move. According to an analyst at HSBC: “The likelihood that long-term dollar weakness will support gold does not obviate the fact that the near-relentless increase in bullion prices recently has raised the possibility that gold is due for a pullback,” HSBC Securities analyst James Steel said in a report emailed today. “A dollar rally, even if only temporary, could provide a reason for gold longs to take profits.”

The Daily Reckoning