Fighting Deflation Instead of Inflation?

Good day… And a Wonderful Wednesday to you! Things settled down a bit yesterday, with the rumors of bailout for Fannie and Freddie Macs fading, and some awful housing data being swept under the rug. The dollar gained back the ground it had lost to the euro (EUR) the previous day, and Japan printed a very strong Machine Orders report… And now Iran tests long-range missiles… All that and more as we begin our Wednesday…

OK, front and center this morning… The housing data from yesterday. Since the media decided to sweep this under the rug, I thought I would make certain that at least Pfennig Readers were aware of the rot on the housing vine. The index of Pending Home resales fell -4.7% in April, a much larger decline than the “experts” forecast. I think what you’re seeing here is simply that would be buyers are holding off as they expect further declines in prices.

Before I go on to other things, there’s something that’s been on my mind for a month now, and I just remembered what it was! Recall when the Existing Home Sales data was strong a month ago, and I said that it must have been the fall in home prices to spur that kind of result? Well… As I thought more about it, I decided to look into a thought I had. The thought was a question… Are foreclosures included in Existing Home Sales data? And, lo and behold, the answer is yes! As long as someone was living in the house when it was foreclosed, which would put the percentage very high, wouldn’t you think? Anyway… There you have it! A price drop, and foreclosures spurred that strong Existing Home Sales report… I knew there was something rotten in Denmark when that data printed!

Well… I was all prepared to talk about the $8 fall in oil prices the past two days this morning, only to come in a see the news story that Iran tested a long-range missile overnight – one that would reach Israel… And voila! The price of oil is climbing again… But since I was loaded for bear this morning on oil talk, I’ll go ahead and give you a bit of what I was prepared to talk about.

I was all prepared to tell you that the $8 fall in oil prices the past two days were a result of the slowing economy worldwide. It was thought that with slowing economies, that inflation would weaken, and thus reduce the need to buy an inflation hedge like commodities… But I was going to refute that notion, and say that we’ve seen these drops in the price of oil several times in the past couple of years, and every time it happens, we get the bugs coming out of the wall boards telling us that the price of oil has stopped rising and that it will now fall back to levels previously seen before the meteoric rise. And to that I would say, “”HOGWASH!” Will Oil go up forever? NO! Have we seen the highs? I don’t believe we have… If this sell off is anything like the previous ones seen, Traders will simply use this lower level as a new base to move higher once again.

I don’t know what’s going on with Iran testing the long range missiles, it looks to be saber rattling to me, given Israel’s test just a couple of weeks ago. Sooner or later, love is gonna get ya’, no wait, sooner or later, I’m afraid that all this saber rattling will escalate to something else. Let’s hope my fears are not proven to be true!

So, the euro lost ground yesterday, when the rumors of another risk event (Fannie and Freddie) faded… And I guess the news that another financial institution was going to cut over half its staff wasn’t enough to make people wonder about the U.S. economy, as dollars were bought all day long.

Overnight however, the euro has gained back the ground it lost yesterday… What the heck is going on here? Ahhh grasshopper, this is simply “noise” in the markets… Up one day, down the next. As long as the underlying trend – which happens to be a weak dollar trend – remains in place, this is just daily noise. European Central Bank (ECB) President, Trichet, said in an interview overnight that “inflation is worrying”. Don’t tell me that Trichet has become the new “Mr. Obvious”! U.S. Treasury Secretary Paulson has held that title for some time now. I think I’ll give Trichet some slack on this one, since this is his first foray into the world of obvious statements!

Speaking of Mr. Obvious, Hank Paulson… Here’s a little ditty that he put out there for us yesterday. Paulson says… “Many Home Foreclosures Are Inevitable” .

Japan captured some magic in a bottle with their Machine Orders posting a 10.4% rise in May. Here’s the skinny… Equipment orders, which signal capital spending in the next three to six months, rose 10.4% from April, when they climbed 5.5%. The experts had forecast a rise of only 1.1%!

The rumors of the Japanese economy’s death have been greatly exaggerated! And I can’t point to it and say its just one report, as this is the second consecutive month of a strong posting in this data! Does this mean the Bank of Japan (BOJ) will react with a rate hike? Not hardly… The BOJ is stuck in the mud, just like the Fed and the Bank of England (BOE). But the BOJ has different problems from the Fed and BOE, who have inflation coming out their ears and no economic growth.

I read my friend John Mauldin’s “Out of the Box” letter yesterday, which was written by Van Hoisington and Lacy Hunt. These two analysts put down a lot of good thoughts that inflation isn’t going to be our problem going forward, but deflation instead. If that’s true, then the Fed’s got an even tougher road to hoe than they do now! And if that’s true… Forget all the rhetoric about raising interest rates here in the United States. If that’s true, you can take a flyer now on lower interest rates and tons of money supply, and easier credit, and well just about anything else you can throw at deflation. You might as well throw the kitchen sink, because Japan has tried all these things during their decade of deflation… And nothing worked!

The G-8 meeting in Japan ended with a whimper. I tell you this… These G-8 ministers are simply in it for the boondoggle. They did nothing, said nothing, and left without a word… Although reports continue to suggest Germany’s Merkel, in particular, was dissatisfied with the failure of the final communiqué to address recent currency movements. Merkel is quoted as saying, “Honestly speaking, we could have imagined one more sentence…that foreign exchange rates must reflect economic fundamentals.”

I think the dollar wouldn’t fare too well with that statement, given its economic fundamentals, and so, the G-8 decided to leave sleeping dogs alone here.

The Canadian dollar/loonie (CAD), has outperformed all currencies overnight, which is about time! The bounce in oil prices overnight has boosted the loonie higher… But in reality it’s a small trading range, so don’t get all lathered up just yet!

The Aussie dollar (AUD) received some not-so-good economic data last night. Consumer confidence plunged to a 16 and a half-year low in July, as rising food and fuel prices are hurting the Aussies as well. The data in Australia, which previously, kept pointing to another rate hike by the Reserve Bank of Australia (RBA), has softened in recent prints, and now suggests that the RBA is finished with rate hikes in this cycle. That will cause some softness in the Aussie dollar, but only while those that were looking for a “quick hit” get out and move to something else. I still believe in the Aussie dollar story, and view this as a temporary situation.

The Indian rupee (INR) continues to get sold… And this is beginning to get old! I was telling someone yesterday that the flows into India have slowed somewhat, and you had the Reserve Bank selling rupees a couple of months ago to keep it from getting too strong. When you have a Central Bank that demonstrates a willingness to sell their currency, traders and investors can choose to fight them, or go along with the selling… Unfortunately, it looks like the latter of the two choices has been the winner, thus a weaker rupee.

The New Zealand dollar/kiwi (NZD) has had a difficult time dealing with the fact that the Reserve Bank of New Zealand (RBNZ) has basically called an end to their rate hike cycle. I’ve said this many times in the past, but for new readers it could be a first, so I’ll say it again… Kiwi has had a wonderful, exciting, and most profitable run for the last six years, but as the currency was being bought because of the high interest rates that could be had there, the country’s trade deficit was rising. The trade deficit has run well over 7% of GDP for a couple of years now, but as long as interest rates were high, the kiwi benefited… But now, if interest rates aren’t going higher any more, or maybe even lowered, the trade deficit comes front and center, and is no longer swept under the rug… Be careful here.

The weakness in oil prices kept gold subdued yesterday, but as you can imagine, the bounce in oil prices overnight has allowed gold to also rebound.

Did you see that Big Ben Bernanke announced yesterday that he is going to continue to allow financial institutions the ability to use the Fed’s lending facilities? Doesn’t that tell you something? Well, it tells me that Big Ben sees the need to keep this option open… And the need is probably that he knows the problems these institutions are experiencing.

Don’t you find it strange that the news stations didn’t carry that news? I shake my head in disgust of the attempt to make us feel good… When people should be warned of the storm clouds so that they can take appropriate action to protect their investments.

Currencies today 7/9/08: A$ .9525, kiwi .7545, C$ .9845, euro 1.5715, sterling 1.9750, Swiss .9695, ISK 75.44, rand 7.6685, krone 5.12, SEK 6.0125, forint 146.40, zloty 2.0775, koruna 14.94, yen 107.40, baht 33.60, sing 1.3625, HKD 7.80, INR 43.15, China 6.8580, pesos 10.30, BRL 1.61, dollar index 72.80, Oil $137.70, Silver $17.83, and Gold… $920.75

That’s it for today… The rain is back… Which left me pretty soaked on my way in today. I’m driving a loaner, so my umbrella isn’t in the car, and if you’ve seen me walk since my surgeries last summer, I don’t get along too quickly… So… Soaked! Baseball’s All-Star Game is next week, two Cardinals made the team (should have been 3!). The All-Star Game is in St. Louis next year, sure hope there’s a way I can find two tickets for me and my little buddy to go! But that’s a year away, no sense thinking about it now! Kristin is on her way to Las Vegas to speak at the Freedom Fest. If you’re going, make sure to stop by to say hi to her! Hey! About a month ago, I did an interview on a PBS radio show called “On The Money”… Our website will soon have that interview as a part of our great currency pages… So check back often to see when it’s available, click on it, and there you go! I hope you have a Wonderful Wednesday!

Chuck Butler
July 9, 2008