Mersch Upsets the Applecart

Good day… And a Tremendous Thursday to you! Another ride on the currency roller coaster yesterday. I’m beginning to get sick to my stomach mom! Seriously, the currencies, led by the euro (EUR) had the rug pulled out from beneath them mid-day by some dude in the ECB named Mersch. This guy really upset the euro’s applecart…. Let’s go to the tape.

The euro was hanging this town on a corner at 1.48 and change yesterday, when ECB member, Mersch warned about Eurozone growth. The thing that really hurt the euro regarding Mersch’s comments is that he’s always been considered a Hawk… And these comments sounded quite dovish. Shoot Rudy, I would have thought everybody and their brother would have known by now, especially if they read the Pfennig, that Eurozone growth was slowing, and if it wasn’t for rising inflation, the ECB would be entertaining rate cuts.

But that didn’t stop the profit takers from hitting the single unit with a shot to the mid section. I went to the bathroom, and when I came back the euro had dropped from 1.48 to 1.4625… OUCH! A trader friend at HSBC sent me a note and said that they had seen 1 billion euros get sold in a 10-minute stretch! But hold on folks. That was nothing but profit taking… For just like I said yesterday about how gold had shot up from $800 to $900 without any profit taking, the euro had shot up from 1.46 to 1.49 and heading to 1.50 without any profit taking.

This is not a trend reversal… Simply holders of euros that had huge profits in them, seeing an opportunity to sell, and even look to buy back once the selling was over, which didn’t last long. Soon, euros were being bid up again, and ended the day 1.4680… Roller coaster…

The Fed’s Beige Book printed yesterday… And in it, the Fed said outright, “The U.S. economy has lost momentum and that the economy might be slipping into a recession.” Well, I hate to differ with them, no wait, I always differ with them! Anyway, I insist that we’re already in a recession, it will take the knucklehead economists a few months to figure it out though!

The Fed’s TIC’s report printed yesterday… This report is so backwards looking it’s ridiculous… But nevertheless November’s tally for foreign investment came in at $90.9 billion, which on the outside looks good, as it is more than is needed for a monthly deficit number of around $80-85 billion. The problem is this… The tally for the year 2007, averages a monthly attraction figure of around $50 billion, far less than the $80-85 billion needed.

Herein lies the dollar’s biggest concern going forward in 2008… I’ve said this a few times before, but for the new readers, here we go… The commercial paper market has dried up… Corporate bond issuance has dried up, all due to the credit crunch going on… Now stocks have lost 1,000 points in the past two months… What’s left for foreigners to buy? That’s right, low yielding Treasuries. There’s just not enough paper to go around to all that want to buy it, which is taking for granted that they STILL want to buy it!

When a country has financing problems, they have only two choices… Allow interest rates to rise to levels that attract the investments, and risk bringing the economy to its knees… Or allow a debasement in the clearing mechanism, which in this case is the dollar… That way, the assets that are purchased are purchased at a discount due to the cheaper dollar. When given the choice to raise interest rates and bring an economy to its knees or allow a debasement of its currency, governments will always choose what’s behind door number two!

That’s one of the big reasons the euro is trading around 1.47, and likely to move to the 1.50-1.55 range in 2008… And the dollar remains in the weak dollar trend.

The Japanese yen (JPY) didn’t fare as badly as the euro and other currencies yesterday, although it did lose ground on the day. Yen strength is tied directly to the unwinding of carry trades, no ifs, ands or buts. If risk continues to get taken out of the market place, yen will perform no matter what shape the Japanese economy is in. There have just been far too many yen shorts put on the books over the past five years or so, which will have to get unwound if risk is removed.

Hey! How about that economy down in Australia? In December, the job shortage in Australia worsened, as employment rose for a 14th month! 20,100 new workers were added in December, following a revised gain of 47,600 jobs added in November! I just don’t see how the Reserve Bank can turn their backs on these numbers… Growth hit 4.3% in the last quarter, and inflation is expected to run higher than the Reserve Bank’s 2-3% target range. This tells me that the Reserve Bank will be revisiting the rate hike table soon… Very soon!

Yes, the Aussie dollar (AUD) will see push and pull forces this year. The carry trade unwinding will push the currency lower, while rising interest rates and a strong economy will pull the currency higher. It will be interesting to see who wins the battle… My two cents are on the pull.

A reader asked me to talk about Iceland… Well… There’s not much to say here that I haven’t already talked at length about. Icelandic krona (ISK) is a high yielding currency, and has benefited from that position as the lead “Investment currency” of the carry trade. Investors sold the yen and Swiss franc (CHF) short because their borrowing costs were low, and bought Iceland, South Africa (ZAR), kiwi (NZD), and to a lesser degree, Aussie and sterling (GBP)… As “risk” gets taken out of the market place due to global slowdown concerns, these carry trades are unwound, thus putting pressure on Iceland and the other high yielders, while propping up yen and francs. Now… Should “risk’ begin to get put back into the market place, we’ll see a reversal of this sell off in Icelandic krona.

With Iceland being such a small country (300K population) the currency swings can be magnified, thus making it a volatile currency. This is nothing new to people who read this letter… But for all the new readers… There you go… My take on Iceland…

The Big Boss, Frank Trotter, sent me a note yesterday on a article printed by Robert Reich, who you may remember was Labor Secretary under Clinton. He was never a “fave” of mine, but in talking about China, and how the new administration will probably impose tariffs on their exports to us, he hammers home some of the same thoughts I’ve hammered on over the years… Here’s a snippet…

“The real problem is that America as a whole is living beyond its means. If anything, China has been an enabler, lending us heaps of money to continue our buying binge including homes with low-interest mortgages. That binge seems to be coming to a close. If American politicians succeed in forcing China to raise its currency another 10 or 20 percent, the binge will end faster than you can say the word ‘stagflation.’

“But not all Americans feel they’ve been living beyond their means and here’s why Congress is feeling pressured to do something about the trade deficit with China: Adjusted for inflation, the median wage is below what it was in 2000. Almost all the benefits of American economic growth have been going to the very top. But China shouldn’t be a scapegoat for this, either.”

That’s right… We, as Americans live way beyond our means, and it starts with the government! Now… How can we fix that, I hear you asking? Ahhh grasshopper, save for a rainy day. If we as consumers begin to save, we can demand that the government stop spending, and save as well.

Now… I don’t live beyond my means… And as readers of the Pfennig, I doubt you do either… So that means those that do live beyond their means have really gone beyond their means! Hopefully it’s not too late!

The bomb dropped by ECB member Mersch yesterday hurt gold and silver too… But while further declines on profit taking are possible, this ongoing credit crunch and mortgage meltdown will likely provide a floor on additional big losses. This looks like one of those buying opportunities, doesn’t it?

Jun Kitazawa, head of foreign exchange at Brown Brothers Harriman Investment Services, agrees… Let’s listen to what he says about this dollar rally… “The dollar selling trend is unchanged, and players are waiting for new trading factors to send the currency lower.”

Well, done, couldn’t have said it better myself! In addition though, we could see the euro take on some more water today… But think about this… The dollar is still very weak! And it will take a miracle of sorts in positive data for months to have any chance of reversing the weak dollar trend… So, as I said above… I would look for the dips, of which this certainly qualifies!

One Asian currency that I keep coming back to, Singapore dollars (SGD), just keeps ticking. Last night, UBS, the world’s second biggest FX trader, forecast a strong increase in the Singapore dollar for 2008… That’s nice of them to join in on my Singapore bandwagon! Seriously though, I’ve said this before… The Monetary Authority of Singapore (MAS) guides the currency, and they’ve indicated that they will allow a faster appreciation of the currency… Since the MAS made that announcement in October of last year, the Sing dollar has gained almost 3%… I know, that’s not great shakes for all you go-go stock guys… But for an Asian currency, that is great shakes. And think about this… You use currency as a diversification tool and hedge against a falling dollar… So, in this case, your “hedge” gained 3% in the past three months! Now that’s a horse of a different color, eh?

Currencies today: A$ .8815, kiwi .7710, C$ .9820, euro 1.4620, sterling 1.9675, Swiss .9040, ISK 65.50, rand 7.02, krone 5.4410, SEK 6.4480, forint 174.85, zloty 2.5675, koruna 17.84, yen 107.40, baht 30.17, sing 1.4350, HKD 7.8050, INR 39.28, China 7.2480, pesos 10.94, BRL 1.7720, dollar index 76.37, Oil $91.09, Silver $15.90, and Gold… $881

That’s it for today… Pretty wordy, but all stuff that needed to be talked about, for sure! Got home in time yesterday to see my little granddaughter, Delaney Grace… She’s jabbering now… DADADADADADA, sounds so darn cute! We’re supposed to get some snow this morning, just in time for rush hour traffic, should be interesting… Not for me though, I’m heading to work and will be there before all the fun begins… I’ve talked long enough this morning, time to head out… I hope you have a Tremendous Thursday!

Chuck Butler
January 17, 2008

The Daily Reckoning