Trichet Deep-Sixes Euro Rally

Well… As you began to read today’s letter, you noticed the title, so there’s no reason to beat around the bush… Let’s just see what European Central Bank (ECB) President, Trichet, had to say that would deep-six the euro’s two-day rally… Come on, it won’t bite…

When asked if the risk signals for financial stability in the Eurozone were flashing red, he said… “Yes”… Hmmm, OK… You’ve got to admire his honesty, if that’s how he sees it, but it’s not what the Eurozone needed at this time… Get past this current debacle in Greece, then, talk about these other problems… That’s what I would do, if I were king…

But, with Trichet, leading the European Systemic Risk Board, I don’t think he had any choice, as the question was directed toward him. Trichet went on to say, that, “The message of the board is that the link between debt problems and banks is the most serious threat to financial stability in the European Union.”

And the euro (EUR) was sent to the woodshed on those remarks. For Trichet opened Pandora’s Box of memories to the collapse of Lehman Brothers… You see, I’ve seen quite a few comments that Greece is going to be the Eurozone’s Lehman Brothers, and we recall what went on after the collapse of Lehman Brothers here in the US in 2008…

So, without the Big Dog euro taking bites out of the dollar, the other currencies can’t find any terra firma either. Shoot Rudy, even the Chinese renminbi (CNY), which normally books some profit versus the dollar every day, weakened overnight against the dollar! OK, the renminbi move was miniscule, but still the point is that it joined the other currencies in weakening versus the dollar…

And gold, which posted an $8 gain yesterday, has sold off by $7 this morning… What goes up, must come down, and the spinning wheel got to go around… That’s exactly what jumped into my mind as I was typing that that gold had gone up $8 yesterday, and back down by $7 this morning…

OK… So, we know that the Eurozone, according to ECB President Trichet, believes there is a serious threat to the Eurozone from all this debt…

Now… let’s skip over to the US and see what’s up their deficit/debt sleeves…

The Congressional Budget Office (CBO), the non-partisan accountant for the government, issued a report yesterday that cuts right to the chase, folks… Here’s the CBO… “In 2021, the CBO predicts debt will reach 76 percent of GDP, but under a more dire – and more likely – scenario, the public debt will be 101 percent of GDP 10 years from now, well into the economic danger zone of 90 percent or more.

“Last year, that worst-case scenario predicted a debt-to-GDP ratio of 87 percent in 2020, demonstrating that the public debt picture has worsened considerably, in part due to a bipartisan tax deal last year that reduced expected revenue.”

They went on to say, “Increasing federal debt will be a growing burden on government action, crowding out lawmakers’ ability to adopt tax and spending priorities in good times and reducing flexibility during recessions, all while making a fiscal crisis more likely and hindering long-term growth.”

So… Trichet highlights the Eurozone’s problems, and the euro gets trashed, while the CBO highlights the US’s debt problems, and the dollar gets bought? On one hand, I say the euro needs to get slapped around a little, but on the other hand, why then doesn’t the dollar get slapped around too?

If that were to happen, investors would flock to gold…and say to heck with those fiat currencies! But, that’s not going to happen any time soon, folks… Eventually, we could see something like that happen, but not now… For now, we have the dollar regime and fiat currencies… And as long as that’s the scenario, we do what we can to protect our investment portfolios, retain some wealth, and come out of this ahead of the people that don’t believe in diversification out of the dollar.

Well… Looky there! I’m this far along in the letter today, and I haven’t said a word about the FOMC meeting yesterday, where rates were left unchanged. The FOMC said that our current rates would remain at current low levels (near zero!) for some time… That’s central bank parlance for at least three more meetings… The main thing about the meeting was the press conference that followed the rate announcement… Where I do believe we saw another case of “two-handed economists”… You know, the ones that say, “on one hand we could see this happen, and on the other hand we could see this happen”… The FOMC downgraded the current economic environment, but on the other hand, they said that they are still anticipating the economy to pick up the pace in the second half of this year.

The FOMC did announce the end of QE2, which is what I thought they would do, but held out hope that they would admit that they are thinking of more stimulus…

PIMCO’s Bill Gross, thinks he’s already hearing talk of QE3… For a while yesterday, the dollar was getting sold like funnel cakes at a state fair, and it was because of a comment that Bill Gross made… Here’s the headline that came across the screens… PIMCO’s Gross Sees ‘Hint’ About QE3 at Jackson Hole Fed Meeting.

Ty sent me the whole quote by Bill Gross, because Ty knows that I hold the late Hy Minsky in very high regard (he was my economics mentor), and Gross talked about Hy Minsky…

OK… Let’s talk about something else… OK, you’re gonna love this one, kids… The Norges Bank (Norway) said to my Pfennig call for another rate hike this year… “Chuck, we’ll see your 1 rate hike, and raise you one!” OK… You know, that they really didn’t say that…but it sure seemed that way! The Norges Bank did leave rates unchanged as expected, but really made krone holders salivate, with projections implying two more rate hikes this year… Most likely August and October. Of course, the Norges Bank did give themselves “an out” on these projections, as they assume that the Greek debt problems will not spread.

And I just noticed that the Canadian dollar/loonie (CAD), is holding steady Eddie against the “southern dollar”… I’ve been keeping track of the data coming through for Canada lately, and it’s all been good… Things like: Unemployment falling, Capacity Utilization rising, Leading Indicators rising, Retail Sales remaining strong, and then something that I find to be very important in projecting economies… The fiscal health of the consumers… And here the Canadians are doing just fine… The market value of Canadian household net worth increased by 1.0% ($64 billion) in the first quarter of 2011 to $6.3 trillion… That brings Canadian household net worth to a record level!

Compare that to the US consumer, and you get a different picture… The average American family has only $3,800 in the bank. 50% of Americans have only $35,000 saved for retirement. They have little in investments, and credit card debt up to their ears… Now… That sounds bleak, but it’s the “Average American”… But if that sounds bleak… Add to their worries, the high price of gas these days, and this from CNBC… “US state and local governments will need to raise taxes by $1,398 per household every year for the next 30 years if they are to fully fund their pension systems, a study released on Wednesday said.”

OK… Enough of that too!

Then there was this… The US is going to raise “net” new cash this week of $50.8 billion, with Treasury Auctions of $35 billion 2-years, $35 billion 5-years, and $29 billion 7-years… I’m wondering how this auction will go… Yes, the Fed is still “in the game”… But with all the problems in Europe, will the Europeans be at the auction table? We know that the Chinese have become disinterested guests at the auction table, and the Japanese have their own problems to deal with right now… Could be a very ugly auction, which could cause some upward pressure on Treasury yields… And halt the dollar’s rally…

To recap… The euro’s two-day rally was stopped in its tracks by ECB President, Trichet, who Opened Pandora’s Box of memories with the collapse of Lehman Bros. Even the Chinese renminbi weakened versus the dollar overnight, which doesn’t happen that often. The FOMC met and kept rates unchanged, announced an end of QE2, and downgraded the economy, but kept the light on for a picking up of the pace for the economy in the second half of this year… And gold gained $8 yesterday, and gave back $7 this morning…

Chuck Butler
for The Daily Reckoning

The Daily Reckoning