Happy Veteran's Day!

Good day…hope everyone had a good weekend; we had some very nice fall weather here in the Midwest. As you all know, Chuck is in Florida until Wednesday of this week but he sent me the following to start today’s Pfennig:

“OK… Today is a semi-holiday with the Fed and Banks closed, but the stock market open… Yesterday was Veteran’s Day… I know I told you this story last year on Veteran’s Day, but since we get 500 new readers every week, that means there are thousands that didn’t see this story…

“Let me set this up, and don’t worry, we’ll get to the currencies in a minute… This is an email my darling daughter Dawn sent to me last year…


“‘Today we had our annual Veteran’s Day Assembly. I submitted the picture of Grandpa Butler last year and it was used again for the power point slide show this year. This year when it came up on the screen… I realized just how much you look like Grandpa. I don’t think I ever noticed just how much you look like him before. It is such a handsome picture of him in his uniform, it brought tears to my eyes. Just thought I’d share!’

“I think of my dad all of the time… But on Veteran’s Day, I truly appreciate what he and so many others did for us today.”

Thanks to Chuck for starting off today’s Pfennig with that nice Veteran’s Day story. While the banks and post office will be on holiday today, the currency markets are in full swing and the carry trade is the big story again. The trigger for this round of carry trade reversals was Morgan Stanley’s downgrading of HSBC Holdings Plc because of mortgage defaults. This downgrade hit the markets just as Deutsche Bank AG announced that losses from falling values of subprime mortgages will likely reach $400 billion worldwide. Credit concerns caused a mass exodus from the carry trades as investors sold higher yielding investments and paid off the loans that they used to purchase them.

The big benefactor of these carry trade reversals? The Japanese yen (JPY)!! Yen moved 3 whole figures on Friday and continued to strengthen over the weekend to trade below 110 this morning. The Japanese yen has now increased 8.94% versus the U.S. dollar YTD, better than both the New Zealand dollar (NZD) and British Pound (GBP). But as readers know, this carry trade has had more lives than a black cat; so another run by the high yielders is still a possibility. Gains in the yen may also be limited on speculation Japanese importers will take advantage of its gains by selling it for other currencies to buy goods overseas.

The big losers of this carry trade reversal are the same currencies that were obvious benefactors of the cheap money, the Icelandic krona (ISK), New Zealand dollar, and the Aussie dollar (AUD). The Australian dollar slumped to an almost three week low against the U.S. dollar as the plunge in Asian stocks caused investors to cut their positions. The currency extended its decline after the Reserve Bank of Australia suggested in its monetary policy statement it may refrain from raising the interest rate in December.

As I will discuss later in today’s Pfennig, worldwide inflation is increasing and the RBA raised its inflation forecast because the economy’s 16-year expansion shows “considerable momentum”. So while the policy statement was not as hawkish as everyone wanted, another rate increase by year-end isn’t totally out of the picture.

It looks to me that this dramatic drop by the Aussie dollar is a bit of panic selling, and looks to be an excellent opportunity for investors who were waiting on the sideline. From a long-term perspective, the Australian dollar is still a buy.

Along with the nice Veteran’s day story, which has sort of become a tradition in the Pfennig, Chuck sent me the following:

“OK… So no data today, but the data cupboard is chock-full-o-data risk the remaining four days this week. After the Big Ben Bernanke testimony last Thursday, the currencies have taken liberties with the dollar…

“And since the recent data hasn’t been kind to the dollar lately… You have to believe that this week’s data risk might play out to more dollar weakness… Of course, we always run the risk of massaged data, which could keep the dollar from falling further. One of those pieces of data that gets massaged like there’s no tomorrow, is the CPI – Consumer Inflation… We all know, or at least I hope we all know, that the CPI is worthless in giving us a ‘true’ picture of inflation at the consumer level.

“We could also see more Banks/Brokerages announcing mortgage related write-downs… At this point the Big Boys have all reported the bad news, so the small fish are all lining up to announce their bad news, as it will look ‘good’ compared to the Big Boys!

“Friday, we saw the monthly trade deficit come in at $56.45 billion… Which isn’t good, but is better than the $60 billion months we were booking before the dollar started circling the bowl. The previous month’s number was revised upward… The August deficit had originally been reported as $57.6 billion. The deficit was revised up to $58.5 billion from the initially reported August level. I truly believe that September’s number will be revised upward too… But don’t let that get into a great major media led ‘feel good story’.”

Chuck mentions Thursday’s release of CPI and suggests, as he has always contended, that the number will not show us a true picture of inflation here in the United States. But while the Fed can certainly play with the U.S. inflation numbers, they have no control over what is being reported by other central banks; and the true picture shows inflation is accelerating worldwide. Japan’s wholesale inflation accelerated in October with the producer price index climbing 2.4% from a year earlier. These surging raw materials costs are prompting major manufacturers to start raising prices of consumer goods, continuing the trend of rising consumer inflation in the world’s second largest economy.

The high price of oil is also forcing up prices in the United Kingdom. U.K. producer prices rose at the fastest annual pace in 12 years in October, exceeding economists’ forecasts, as manufacturers passed on record oil costs to products including food, gasoline, and chemicals.

Another country announcing a big move up in inflation was China where producer prices rose again in October. Factory gate prices climbed 3.2% from a year earlier. As I mentioned earlier, the Reserve Bank of Australia raised its inflation forecasts, and even our own Fed Chairman Ben Bernanke told congress last week that oil prices will likely put renewed pressure on inflation. With all of this inflationary talk, interest rates worldwide will continue to increase except here in the United States where the economy is stalling.

As we have pointed out over and over again, the U.S. economy is slipping into a very scary scenario of rising inflation and a slowing economy. With the Fed unable to raise rates, they will likely continue to ‘massage’ the inflation data to try and cover it up. But just like the little kid who pushes his green beans under the edges of his plate at the dinner table; the lies will eventually be exposed. After doing their best to cover it up, the Fed will be faced with runaway inflation and a freefall of the U.S. dollar.

Central banks from Bogota to Mumbai are trying their best to control the fall of the dollar. Instead of using currency reserves or interest rates to influence foreign exchange markets, central banks and finance ministers are setting up obstacles to keep the falling dollar from threatening company profits and economic growth. The Reserve Bank of India created a bureaucratic thicket to curb speculation by foreign money managers.

The falling dollar is beginning to threaten the economic expansions in some countries that rely on exports to the United States. Infosys Technologies Ltd, India’s second largest software exporter, cut its full year earnings forecast on October 11, blaming the rupee’s 13% rise. India may miss its $160 billion target for exports in the year through March 31 as local goods become more expensive abroad. Unfortunately for the Indian central bank, these noninterest rate methods to stabilize currency flows have not traditionally worked. The fall of the U.S. dollar is due to the structural weakness of the U.S. economy, and putting up bureaucratic barriers on currency investors will not stem the fall of the dollar.

Currencies today: A$ .8842, kiwi .7487, C$ 1.0452, euro 1.4567, sterling 2.0726, Swiss .8878, ISK 61.11, rand 6.7631, krone 5.4011, SEK 6.4070, forint 174.86, zloty 2.50, koruna 18.28, yen 109.52, baht 31.58, sing 1.4485, HKD 7.7884, INR 39.28, China 7.4145, pesos 10.94, BRL 1.7650, dollar index 75.809, Oil $95.39, Silver $15.14, and Gold… $816.72

That’s it for today… Mizzou wins again, and the Illini knocked off #1 Ohio State, increasing the chances for the Tigers to get to the Championship game. The St. Louis Rams finally won one, probably keeping us from the #1 draft pick (the sorry Rams even lose when they win!!). Congratulations to Al MacInnis who will be inducted into the hockey hall of fame tonight. One of Al’s sons is the same age as my son Brendan and they played on the same little league team so I got to know Al pretty well over the last few years. He absolutely deserves all of the accolades; not only is he one of the best defensemen to ever play the game, he is absolutely one of the classiest individuals I have ever met. Just a great guy!

Chris Gaffney
November 12, 2007