Downgrading Japanese Debt

Every winter, economists and finance ministers and central bank governors, and just about anybody else who could stand to sit and listen to hours upon hours of economic speak, get together in Davos, Switzerland… And from that boondoggle, we normally get quite a few “Pfennig worthy” statements. This year is no different, as we already have received some that “qualify”… So… We’ve got that going for us today, along with the results of the Cartel’s meeting yesterday. So, strap yourself in, all legs and arms must remain inside during your ride…

Front and center this morning, there’s news overnight that S&P downgraded Japan’s Credit Rating… This is HUGE, folks! Standard & Poor’s lowered its rating on Japan to AA- from AA, citing lingering deficits that it said will reduce the government’s already-weak fiscal flexibility. The firm also said Japan’s fast-aging population challenges its fiscal and economic outlook.

Again… The ratings agencies show up with their “late to the party” ratings… Japan’s deficit has been huge for years now, so why is it important for S&P to downgrade them now? Well… OK, my conspiracy blood is really boiling over right now, so I’m going to throw this out there and see if it sticks… S&P is just getting tuned up for a run at the US’s credit rating… Now that would take some intestinal fortitude to do that, and I’m pushing the envelope there, thinking that S&P has that kind of intestinal fortitude, but, I’m willing to take that chance! Don’t think that a downgrade can’t happen here? Don’t bet the house on that, folks… It’s coming…

Oh, and before I go on… Yen (JPY) dropped versus the dollar on the rating cut announcement, and traded back over the 83 handle, but as I look at it right now, yen is back to an 82 handle… But then the US traders haven’t seen this news yet…

So… Back to the deficit thing in Japan, and my thought that a rating cut could very well happen here, and sooner than most people think… Yesterday, the Congressional Budget Office (CBO) announced that their latest computations lead them to believe that this year’s budget deficit will be near $1.5 trillion! That’s trillion with a capital “T”, folks! That will push our national debt to more than $15 trillion!!!! It’s coming, folks… And what will that do to yields on Treasuries, I hear you asking? It will send them to the moon, and it will deep six the dollar… And why would the US be different than Japan, for the yen is not collapsing? The difference, as I’ve explained many times in the past is the difference between the Japanese consumer and the US consumer… They save… we don’t…

OK… So… The euro (EUR) continues to gain ground versus the dollar this week. Yesterday, the euro was around 1.37 as I wrote the award winning, journalistic phenomenon, called the Pfennig. But during the trading day, the single unit slipped about 1/2-cent… But this morning, the euro is back above 1.37, and looking pretty healthy trading there. The theme this week is all about the markets feeling better about the euro’s prospects with Germany behind the wheel. And with that feeling better, we’re seeing quite a few institutions, calling off their calls for a HUGE drop in the euro this year… For instance, DWS Investment Gmbh, Germany’s biggest mutual fund manager, reversed their call for a return to parity in the euro, and now says that the euro may reach 1.50 this year…

That’s pretty interesting stuff, eh? Oh sure, there are still many out there that believe that no matter what Germany does, the euro is doomed… Of course these are the same people that thought that in 1999, 2005, 2008, and 2010… 1999 was the introduction of the single unit, and 2005, 2008 & 2010, were all short-term dollar rallies that confused people into thinking the euro was going to collapse… Have I mentioned lately that these guys and gals were wrong?

The FOMC ended their two-day board-game-apalooza yesterday, and when they did, everyone was left wondering why the heck they took two days to make the statement they made! Big Ben Bernanke and the Fed Heads left rates unchanged, and basically said the same thing they said six weeks ago… They also mentioned that they were going to go ahead and continue the bond buying program, otherwise known as QE2…

This, no change in status, really lit a fire under the currencies, but that didn’t last too long for currencies like the Aussie dollar (AUD), which rallied to parity, and then sold off all night long. The reason the Aussie dollar would have been a knee-jerk reaction is that rates in the US are going to remain at zero for some time to come, and those currencies with a yield advantage should be reaping the rewards.

That brings me to a thought that I think I’ve gone over with you before, but it doesn’t hurt to circle back and go through it again… And that thought is… Interest rates in the US can’t go up… Think about this… All the debt that we keep running up here in the US has to be financed, right? We use the issuance of Treasuries as our financing tool, right? OK… These Treasuries have an interest rate that’s tied to them, that pays the holder of the Treasury every six months… Right now, with interest rates low, and Treasuries being issued with low yields, the US is struggling to meet the interest payments, as tax receipts continue to fall… Well, if interest rates move higher, so do the yields on Treasuries, which means as interest rates go up, so does the amount of payment the US has to make to the holder! It’s all there… Right there in front of us… And yet, the markets fail to see this…

OK… This plays well with my continuing thought that home prices will continue to fall… Speaking from Davos, one of my fave economists, Nouriel Roubini, had this to say about home prices… “If you look at the data, Case Shiller has been falling every month since the tax credit expired in May. Everyone who wanted to buy a home did so by April. That tax credit stole demand from the future and its expiration led to another 30% fall in home sales, pushing Case & Shiller lower for the last few months.”

Roubini also believes that housing has double dipped… And… Well… I think I told you that several times in the past…

Well, the Reserve Bank of New Zealand, (RBNZ) left rates unchanged yesterday, as I told you I thought they would… But what was interesting was the statement by RBNZ Governor Bollard… Let’s listen in… “Forward indicators of activity have firmed somewhat. Trading partner activity continues to expand and New Zealand’s export commodity prices have increased further. Within New Zealand, business confidence, across a range of industries, has picked up and imports of capital equipment have grown. Furthermore, there are tentative signs that housing market activity has stabilized, after having trended lower for some months.”

Sounds like a central banker that’s laying the groundwork for a rate hike later this year, when he can point to how long he’s been talking about things in the economy that have been improving.

In Australia… The problems to the economy that the floods have caused will continue to mount… But here’s a story that you’ll not hear anywhere else, folks… There’s a milk price war going on in Australia, with milk prices dropping, which could help to offset the rising prices of agriculture that was ruined by the floods… That reminds me of when I first began driving a car… In the area of the city that I lived, every street corner either had a gas station, a bar, confectionary, or some other business… And the gas stations would have “gas price wars”, where you could drive back and forth, and get gas for 25-cents, 24-cents, 23-cents, and so on… As Archie Bunker used to sing… Those were the days…

The Aussie dollar – which had rallied yesterday afternoon on the yield differential realization after the FOMC left US rates near zero, but sold off overnight – is taking it on the chin, this morning… Australian Prime Minister, Julia Gillard, announced a one-off levy to help pay for reconstruction… The levy won’t be that big of a strain on the economy, but the fact that it was imposed was enough for traders to take their bets off of a rate hike in Australia in 2011… Me? I’m still leaving the light on for a rate hike later this year… But that’s pushing back my previous thought that rate hikes would begin appearing by the end of the first quarter… UGH!

The Bank of England (BOE) held rates steady yesterday, but not without some sawdust being left on the floor of the meeting room… Two BOE members voted to hike rates, and one member voted to cut rates, while the rest voted to remain steady… I would think that, with the inflation pressures all around in England that we talked about the other day, a rate hike isn’t that far off in England’s future. Well, I’ll say this… It had better be, or else they will suffer from runaway inflation… And that won’t be pretty.

I saw a great quote last night that made me laugh and cry at the same time… OK… Let me set this up for you… We all know that the Fed Heads and their leader, Big Ben Bernanke have repeatedly said that inflation in the US was too low, and they were going to attempt to stir inflation, right? OK… Here you go… If inflation is good for the economy, why isn’t Zimbabwe the wealthiest nation on earth?

Gold and silver are getting whacked again this morning… Yesterday they rallied on the news that the US was keeping interest rates near zero… But this morning, it’s back to taking long trips to the woodshed for these two. I keep seeing people talking about the demand for wealth protection being reduced because of the improving US economy… That’s all HOGWASH! Did these same people not see the CBO’s announcement yesterday? OR… Has everyone become comfortably numb with our deficit? Just remember this, folks… When dealing with non-believers, it’s a battle of words, and most of them are lies…

Then there was this… One of the great analysts in this country is Richard Russell… And if you recall, I wrote about the dollar index approaching a level that it had touched three times before and bounced off…. But if the dollar index traded and remained below the psychological level, then we could see the dollar really begin to fall again… Well, Richard Russell saw it too, and had this to say to his readers…

This is the US Dollar Index. Today there’s no definition for the dollar. So how do we price the dollar? At one time, the dollar was priced in terms of the time-honored standards – gold and silver. But today we must price the dollar against other fiat currencies. A dollar is worth so much against the yuan, or so much against the pound sterling, or against the euro and so forth.

Thus we have the Dollar Index, an index that pits the dollar against six other fiat currencies. To get back to the chart, we see that the Dollar Index is now trading below its blue 50-day moving average. The 50-day, in turn, is below the red 200-day MA. Thus, the Dollar is in the classic bearish configuration as long as it trades below its 50-day MA.

The Russell advice – swap your dollars for physical gold or CEF, GLD, or SGOL. In other words, do as China and Russia and many other nation are now doing – get out of your dollar assets.

…I realize that what I’ve written above may seem outlandish to many subscribers. Outlandish? Then you tell me how the US is going to finance a national debt of $13.9 trillion (some say the real debt is over $50 trillion). The fact is that we now BORROW just to pay the interest on the national debt. Treasury is moving the debt to ever-shorter maturities, hoping that the current zero interest rates on short debt will ease the situation. But with bonds sinking, rates are now rising, so what’s the answer?

Well… We all know what the answer is…don’t we!

To recap… S&P downgraded Japan’s Credit Rating from AA to AA-, and sited their indebtedness… OK, so when is S&P going to say the same about the US? The CBO updated their forecast for 2011, and said that the budget deficit will be near $1.5 trillion this year! The euro weakened in the afternoon yesterday, but has rallied again this morning above the 1.37 handle. The FOMC left rates unchanged, like they have any other choice, and said they would continue their bond buying program, AKA QE2…

Chuck Butler
for The Daily Reckoning

The Daily Reckoning