Feeling Stronger Every Day

Good day… I’m going to start off this morning with Chuck’s contribution, as he has a quick update on his recovery progress:

“Happy Friday everyone… I’m still getting better every day. And although I’ve already expressed my appreciation for all the thoughts and prayers everyone sent me, I must make mention once more of how I was moved by them. They were uplifting, and truly helped in getting me back on this recovery road. I’m not out of the cancer woods yet, but I think I can see the light! Once again thank you from the bottom of my heart!

“I’m going to spend some time this morning on commodities. They’ve been on my mind lately, so I spent some time doing some additional homework on what’s going on with commodities, and the commodity currencies.

“ANZ Bank has a World Commodity Price Index that I take a peek at now and again, and in my homework assignment I found that the Index rose 4.7% in July. Dairy prices led the way with a 7.8% rise in July. (I told you about the price of milk last week, eh?) So… With commodities on the rise, it’s no wonder the Aussie dollar (AUD) remains well bid. (In other words… There are lots of buyers). The New Zealand dollar (NZD) dampened last month… But really, look at the value of this currency and think back to February of 2002, when I told anyone who would listen to me that the “strong dollar trend” was over, and a “weak dollar trend” had taken over… Kiwi is up almost 90% versus the dollar!!!!!!

“OK… Back to Australia, since that currency remains well bid, employment rose by a solid 21,800 in July reflecting higher full-time employment. The unemployment rate was unchanged at a three-decade low of 4.3% and the participation rate remained elevated at a peacetime-high of 65.0%.

“Today’s figures reinforce the picture of buoyant conditions in Australia’s labor market and add to the reasons why yesterday’s rate increase will NOT be the last chance saloon for higher rates!

“I’ve talked till I’m blue in the face about the mortgage meltdown, and how I disagree with the Fed and a lot of other market analysts, that the subprime mess was going to extend its tentacles to other parts of the economy and markets.

“Well… Here’s some fuel for my thoughts… Reuters reported yesterday that the AMERICAN INTERNATIONAL GROUP DATA SHOW DELINQUENCIES MOVING BEYOND SUBPRIME TO PRIME MORTGAGES.


That is exactly what Bernanke and Paulson must be saying right about now. They were both sooo wrong when they kept insisting the subprime mortgage industry’s problems were contained. The $2 trillion dollar mortgage market is at a standstill, and as Chuck points out up above, the problems are moving beyond the subprime market. Firms and banks that package the debt for investors are taking big hits to their bottom lines, and the housing slowdown is being blamed for earning shortfalls across industries.

A story I read on Bloomberg this morning pointed out how the rhetoric from these two talking heads has changed over the past few months:

“Bernanke told Congress on March 28 that subprime defaults were ‘likely to be contained.’ The Fed chief changed his assessment last month.

“On July 18, he told Congress that ‘rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities – problems that likely will get worse before they get better.'”

“Paulson said June 20 that the subprime fallout ‘will not affect the overall economy.’

“This week on CNBC, he provided a less definitive assessment, saying that the markets have been ‘unsettled largely because of disruption in the subprime space.

“‘We’ve had a major correction in that housing sector’ Paulson said. ‘It will take a while for the impact of that to ripple through the economy as mortgages reset.'”

Well at least it seems they are finally realizing this whole ‘housing adjustment’ is a little more than just a temporary slowdown. I guess some people have to be hit over the head before they get the picture. As I pointed out yesterday, other central banks are not hiding their heads in the sand, and have jumped out in front of the liquidity crisis.

The European Central Bank loaned 61 billion euros (EUR), pumping funds into the banking system for a second day. This action “aims to assure orderly conditions in the euro money market,” the ECB said in a statement earlier today. The overnight rates banks charge each other soared to the highest in six years yesterday after a reluctance to lend money was caused by a concern over U.S. subprime mortgage losses. The ECB treated this situation as an emergency and used the tools it had available to calm the markets.

The Bank of Japan and Reserve Bank of Australia also provided liquidity to their markets. The Bank of Japan added one trillion yen (JPY) to the financial system and the RAB lent the most in more than three years. Again, these central banks were reacting to a liquidity crisis caused by fears of further losses due to the subprime mortgage mess.

A reader yesterday said I was being too kind regarding the ECB, labeling the added liquidity as a bail out; and lauded our own central bank for staying out of the markets. As I pointed out to him, the added liquidity was hardly a bailout, as the central banks were only supplying liquidity to the banking system, not buying back any of their subprime investments. This is exactly the job of a central bank, to provide liquidity in times of need. Choosing to react to the crisis instead of just putting their collective heads in the sand shows just how much more in tune these central bankers are with their economies.

A true “bailout” would see central banks lowering interest rates in spite of increased risks of inflation. This is what those that rely on higher stock prices are calling for, and is just what Bernanke’s predecessor, Alan Greenspan, did more than once. Hopefully Bernanke will be able to avoid these calls for lower rates and stand his ground versus inflation.

So what has the dollar done in the midst of this credit crisis? It has risen. While this rise seems counter intuitive, there is a fairly good explanation. With world equity markets falling and risk again becoming a dirty word, investors have moved back into the ‘safest’ investment in the world: U.S. treasuries.

The only currencies that have held over the past week are the Japanese yen and the Canadian dollar (CAD), both of which were up slightly on the week. The Swiss franc (CHF), euro, Norwegian krone (NOK), and Swedish krona (SEK) were all down over the past week, but less than 1%. This is an excellent buying opportunity for these currencies, as the move back into U.S. treasuries won’t last. Interest rate differentials will continue to favor investments outside of the U.S. dollar and money will again move back out of the dollar.

Defensive positions would see money moving into the Japanese yen, Swiss franc, or euros along with investments into gold or silver. Gold rose in Asia underpinned by demand from jewelers after the precious metal tumbled the most in three months yesterday. Silver gained also. The drop in gold yesterday came as investors sold bullion for cash to cover losses related to the U.S. subprime collapse. The price drop spurred some buying from jewelers, who account for almost 70% of gold consumption.

The Chinese renminbi (CNY) is another good hiding place amongst all the market turmoil. China reported their trade surplus surged 67% in July to the second highest on record. China also reported their money supply grew at the fastest pace in more than a year, adding pressure on the government to allow faster renminbi gains. M2, the broadest measure of money supply, rose 18.5% in July from a year earlier. The Central bank has raised interest rates three times this year, but needs to let the currency appreciate faster to reign in some of this excess liquidity. As an economist at JPMorgan said in a report this morning, “the root cause is the undervalued currency, other measures are like using a bucket to deal with a flood.”

The top priority is to prevent the economy from overheating and keep prices tamed, the central bank said in a quarterly monetary policy report this week. An excellent way to make this happen would be for the government to let the Chinese renminbi appreciate. A 5 to 10% move would be a good first step.

Currencies today: A$ .8436, kiwi .7421, C$ .9482, euro 1.3661, sterling 2.0182, Swiss .8361, ISK 65.96, rand 7.2188, krone 5.8470, SEK 6.8006, forint 185.05, zloty 2.7641, koruna 20.5386, yen 117.63, sing 1.5231, HKD 7.8188, INR 40.62, China 7.5735, pesos 11.04, dollar index 80.848, Silver $12.625, and Gold… $660.23

That’s it for today… Looking forward to the Cardinal game this evening. The whole office (and spouses) are heading downtown for the big event. We got a visit from Jennifer and little Drew yesterday. Jen looks great and Drew is even cuter than his pictures. Everyone on the desk was commenting on how good he was, letting everyone pass him around and never complaining. We will see both Jen and Chuck at the game tonight, should be fun. GO CARDS!!! Have a great Friday and an even better weekend!

Chris Gaffney
August 10, 2007

The Daily Reckoning