Mr. King Sounds Dovish

Good day… And back to the cold weather of St. Louis! The trip to Jacksonville was short-n-sweet, and it was nice to see all the people there again. The Big Boss, Frank Trotter, is spending the better part of this month in Jacksonville. I guess the cold weather here got to him! HAHAHAHAHA! Frank is a cold/snow skiing person!

OK… Yesterday morning the ball was in the currencies’ court… But today, it has gone back over to the dollar’s court. It happened overnight. First, The Bank of England’s Governor King mentioned that he believed inflation in the United Kingdom might decline “quite sharply” in the second half of this year. The pound immediately began to get sold, and pulled the euro along for the ride.

Here’s the skinny… The pound has been outperforming the euro recently, so even though the euro is the Big Dog on the porch, the pound has flexed its muscles recently, and the euro has let the pound rule the porch for now. So… When Mr. King decided to talk about inflation falling, it led traders to believe that he was saying that interest rate hikes would come to an end. I think he bit off more than he could chew with that statement, and I wouldn’t be too surprised if the “spin doctors” in the United Kingdom got him back out there with a follow up statement that “fixes” the inflation one.

Maybe Mr. King hasn’t noticed the move up in the price of oil since breaching $50 briefly last week, for if oil continues to rebound, Mr. King will have egg all over his face with that statement. But then, Mr. King has had egg all over his face before. Recall in August of 2005, when the Bank of England “surprised” the markets with a rate cut? I called them out on that move… And the Bank of England had to come back to the rate hike table throughout 2006 to reverse that fateful August 2005 move.

OK… Enough on Mr. King and the Bank of England. In Australia, the Aussie dollar saw some selling overnight after the printing of Australia’s fourth quarter inflation report saw consumer inflation fall, thus relieving the pressure on the Reserve Bank of Australia (RBA) to raise rates. Whew! That was a long run-on sentence, eh? Anyway… With positive move in consumer inflation, the RBA probably won’t move rates higher at their next meeting, which is in the first week of February.

However, I would like for the RBA to take the European Central Bank’s (ECB) approach to this falling oil price, and not let it get in the way of how you view inflation. The ECB as I’ve explained several times in the past, uses a two-headed method of determining rate movements… inflation and money supply. The ECB also looks forward, and does not let the current environment (i.e. falling oil prices) enter into their goal of providing price stability.

That was a strange out of body experience for me. I’ll explain. For 15 years I’ve written about how other Central Banks should pattern themselves after the Reserve Banks of Australia and New Zealand.

But this placing the ECB on a pedestal has been the story. Think about it… In 2000, just a year after the introduction of the euro, the currency couldn’t buy a friend… And ECB credibility was at the forefront of the euro’s problems. So, in just six years, the ECB’s credibility is now front-and-center among Central Banks in the world! And that, my friends, is a big reason the euro now trades at 1.30, instead of the 82-cents it hit in October of 2000!

Now… six years later, the euro is seriously talked about as a real challenger to the dollar as the world’s reserve currency. In the just completed Review & Focus (that goes to clients of World Markets) I spent a lot of time on this subject, and talked about the oil producing countries receiving a “double whammy”, with falling oil prices, and a weak dollar… Not that we feel any “pain” for the oil producing countries… But if they are going to unload dollars, we need to know!

Every now and then, sort of like once in a blue moon, the Aussie dollar and the New Zealand dollar/kiwi trade in different directions. And that happened last night, as kiwi did not get pulled down with the Aussie dollar. Kiwi is taking the high road and maintaining its yield differential to the rest of the industrialized world, and struttin’ it down the street! Kiwi has touched 70-cents this morning… WOW!

There seems to be more and more talk these days regarding China and its plans to diversify their over $1 trillion in dollar reserves. Chris/Ty were kind enough to send me an article that was in the Financial Times yesterday. Here you go…

“When you have a tiger by the tail, what can you do? Changing your grip may bring temporary respite, or calamity. Most likely it will make little difference. China’s plans to diversify its ever-growing dollar mountain, while vague, are a welcome sign that the country will not try to sustain the unsustainable forever. They are not, however, meaningful steps towards repairing the cracks in the Chinese economy.

“China’s foreign reserves, the world’s largest, are now more than a trillion dollars. They are expected to increase by several hundred billion dollars more over the next year. Small wonder there is so much interest in how they are managed and where they are invested. Much of the money is now in U.S. Treasury bonds, but following this weekend’s announcement by Wen Jiabao, China’s premier, it may eventually be managed more ambitiously, and by one or more new agencies.”

Chris told you yesterday about the story on the street that the oil producing countries are not able to buy as many Treasuries as they once did when oil was $70. Add this story to the one above from the Financial Times, and you have to wonder… Who is going to buy/finance our debt? Uh-oh… Here we go down the slippery slope of currency debasement. Mark my words… That’s what poor Henry Paulson will have no other choice to do, when the debt is not being financed.

As I told the group in Jacksonville on Monday… The U.S. data has perked up in January, and doesn’t look as bleak as the stuff that was printing in the fourth quarter of 2006. The Fed is not out of the woods by any stretch of imagination with regards to inflation, and the December leading indicators vouch for that as they began to recover from months of negative readings. But… I’ve seen this type of “dead-cat bounce” in economies before. You think the worst is over, and then “Whack!” Be careful out there!

The recovery in gold and silver continues. This time around, I think gold is being bought out of fear… Fear of an escalating problem in the Middle East, namely Iran. I try to put that stuff out of my mind, but when you do think about it… Buying gold comes to mind… And I think this is what is moving gold higher these days.

Currencies Today: A$ .7845, kiwi .6998, C$ .8480, euro 1.3010, sterling 1.9755, Swiss .8020, ISK 69, rand 7.13, krone 6.3950, SEK 6.9720, forint 195.55, zloty 2.99, koruna 21.57, yen 121.40, baht 36, sing 1.5360, HKD 7.8030, INR 44.24, China 7.7725, pesos 10.95, dollar index 84.78, Silver $13.23, and Gold… $643.60

That’s it for today… I think I confused some people last week when I talked about “our little Christine” and her new baby… Christine is a young lady that works for me… I think some people thought that I was announcing my darling daughter Dawn’s new baby… That won’t come until August! We’re getting closer to the World Money Show in Orlando Feb 7-10… EverBank will be there in full force, so come by and see us! Have a great Wednesday!

Chuck Butler, January 24, 2007

The Daily Reckoning