Eating dollar-denominated crow
Just as I loudly trumpet my correct calls in gold and sterling, I must also eat crow for my missed calls. I predicted a dollar rally that didn't happen, and a fall in the euro which also didn't happen.
I recently prematurely declared that the European Central Bank's $500 billion repo “injection” amounted to unconditional monetary surrender (a “Vichy moment”) on the part of the European monetary authorities. It turns out that the ECB had a large amount of repo rollovers due, and did not actually inject liquidity: the “injection” was a smoke-and-mirrors media event of little real consequence, much like the Federal Reserve's cutting the discount rate (not the funds rate) at the end of August.
However, the fact remains that the ECB has to devalue the euro, or the Portugal/ Italy/ Greece/ Spain “PIGS” will leave. A richly valued euro is very good for northern Europe (Germany, Austria, the Netherlands and Scandinavia), and extremely punitive towards southern Europe, whose economies rely on low- and medium-end manufacturing exports. A strong euro crushes those exports and renders imports (i.e., Chinese goods) even more artificially competitive. Club Med unemployment, already stratospheric, will only go up under the euro framework, triggering more political volatility and louder calls to exit the euro currency union. Club Med budget deficits are also extremely high, and an appreciating euro makes those deficits more difficult to repay.
Any currency trader knows how volatile currency trading can be, and more and more currency movement is now subject to more and more unpredictable central banking decisions than ever before. Meanwhile, competitive currency devaluation by China, the United States, and soon the European Union will only erode the value of individual forex traders' positions. Meanwhile, the prognosis for the sterling is the worst of all.
My worldview of competitive currency devaluation remains unchanged. I am extremely bullish on commodities; extremely bearish on bonds; neutral to mildly bullish on equities; and I am still betting on reflation. I believe the current Merrill Lynch and Citigroup write-downs and recapitalizations mark a bottom in the market in the medium term. Unless the dollar drops drastically, there is simply too much money in the market for it to continue dropping in nominal terms.
While the media continues to drown out valuable information with regards to the “credit crunch,” I simply do not see one happening across the dollar spectrum. Obviously, many traditional financial institutions are facing a brutal crunch. But hedge funds, particularly John Paulson's funds, Citadel, Medallion and others, have made tens of billions of dollars which need to go somewhere. I can only look at monetary and lending aggregates and wonder, “What credit crunch?”
The dark red and blue lines represent two different methods of valuing the dollar relative to other global currencies. The “narrow” valuation is the one more commonly quoted, because it's the more apocalyptic of the two. The “broad” trade-weighted valuation includes the Chinese yuan and other currencies which do not trade much outside the country of issue, but which remain hugely important in global trade. According to the less apocalyptic and more accurate dollar valuation, the dollar is worth the same now as it was in the beginning of 1997, before the Asian financial crisis; a 75% collapse in the price of oil; the default of Russia; and European preparations for a new, common currency, all caused savings to flee French francs, German deutschmarks, Russian rubles, Thai baht, won, and Saudi riyals in favor of the US dollar. When examining global macroeconomic trends, it is essential to keep in mind how exceptional the late 1990's were, and how favorably those various dominoes fell out, all to the enormous relative benefit of the United States.
Getting back to the aforementioned graph, as of January 2, 2008, commercial credit including foreign-related institutions, i.e., hedge funds, is expanding at its most rapid year-on-year rate ever since the TOTCI lending statistic was born on January 2, 1973. That does not look like a credit crunch to me. In my ill-fated medium-term forecast from two months ago, I became bullish again. I had added up the quarter trillion dollars pumped into the economy by the Federal Home Loan Banks, the sixty-plus billion added by the Federal Reserve's Term Auction Facility, and unknowable but significant “temporary” billions in Fed repurchase agreements. I was not at all surprised to see the 2007 “Minsky moment” reverse itself, and commodity prices soar.
Here is the same graph, from January 1 2005 onwards:
The credit “crunch,” i.e., the slowing in the rate of growth of commercial credit (dark green), began in late 2006. Its temporary denouement occurred at the end of February 2007, when the Shanghai markets hemorrhaged 20 percent in three days. Then, at the end of July, what we know as the “credit crunch” began in earnest. Unfortunately, the Federal Reserve persuaded itself that it could repeal the laws of the business cycle and erase bad debt via inflation.
The latest FOMC futures predict a coin toss between 50 and 75 basis points' easing by the Federal Reserve at its upcoming January meeting. Seventy-five basis points strikes me as absolutely incredible, given the explosive appreciation of gold, the acute permanence of dollar weakness, and so on.
I predict an exodus of money from bonds, and significant gains in equities in the near future. For the value-focused investor, bonds have become radioactive. The trade-weighted convertible-currency value of the dollar (the blue line, and the “narrow” metric of valuing the dollar) fell from 83 to 73 – a decline of 12 percent – in 2007. Treasuries appreciated 7.3 percent in nominal terms in 2007, but after adjusting for the loss in value of the USD, Treasuries depreciated by 4.7 percent.
In any case, the commodities boom – now a derivative of Chinese hyper-capitalization – will continue until the Beijing Olympics are over. Until the ECB devalues the euro, the commodities boom should continue, and global imbalances should become more pronounced, not less. Oil will stay in the clouds until China comes to an internal reckoning over soaring and massively understated domestic inflation. Until the Europeans and Americans force the Chinese to float the yuan, a la the Plaza Accord to float the yen in 1985, the commodities gold rush will continue.
The Bottom Line
- Gold/ commodities: very long
- Dollar: neutral
- Euro: neutral
- GBP: short
- Equities: long
- Bonds: short
Thanks as always for reading,
Alex Forshaw,
Editor in Chief
http://www.bestwaytoinvest.com
PS: If you enjoy our commentary, be sure to check out our newsletter's blog, http://cartmanist.wordpress.com, for further market commentary.
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