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Tuesday, March 19, 2024

Monday Monetary Madness – The Dollar Starts to Look Good!

Good golly what a mess the World is!  

You know it’s bad when the US begins to look responsible compared to other World governments but even Alan Greenspan is now calling for an end to the Bush Tax cuts before they cost us another $3.6Tn over the next decade (and that’s assuming no inflation and steady earnings) and we have Paul Ryan and the President calling for Trillions more in deficit reduction so I guess we SOUND serious about cutting our deficit and WE SHOULD BE because the IMF this week said the U.S. budget deficit was on course to hit 10.8 percent of nation’s economic output this year, tying with Ireland for the highest deficit-to-GDP ratio among advanced economies.  

With QE2 winding down in 2 months and no QE3 on the horizon, we can finally turn around and look at the policies of other nations, as the tidal wave of new dollars pulls back and exposes their own, smaller, montetary schemes.  The rest of the World is crying Uncle Sam as most Central Banks are mandated to fight inflation and that has been an impossible dream while the US runs the money spigots.  Even worse, relatively lower US lending rates sets up a new global carry trade, threatening to make the US the new Japan as Dollars are sold (devalued) Globally and high-yield currencies are bought, making the Dollar relatively weaker and crippling trade for other nations as well as devaluing their Dollar-denominated assets (including debt notes!).  It was bad enough when Japan did it and the Yen is less than 10% of all Global currency – the Dollar is 62%.

As this has already been going on for months, there is a strong possibility of a short squeeze in the Dollar as QE2 winds down unless the carry traders get a clear signal that the US will keep printing money.  Even now, Geithner is doing his best to keep the Dollar down (and the markets up) by continuing to demand that China strengthen the Yuan and help to reduce their external surplus.  While pledging that "the United States will do its part to address our external deficit and repair our public finances," he also said, "Others, especially those whose fundamentals call for greater exchange rate flexibility must also contribute" toward the goal, in an apparent reference to China.   

The flood of Dollars around the World has already led the IMF to take the fairly drastic step of endorsing capital controls.  This  marked a reversal in its longstanding opposition to limits on the free flow of capital around the World.  IMF officials have come to acknowledge emerging markets’ need to curb surging inflows, which can fuel asset bubbles and inflation and hurt domestic exporters by driving currency values higher.  The IMF’s plan would have encouraged nations to treat capital controls as a last resort, after they had first tried use other tools, such as policies on interest rates, currency values and government budgets.  But ministers of developing economies resisted vehemently, viewing the proposal as an effort by advanced economies to hamstring their policies. Brazil, Turkey, South Korea and several other developing countries have adopted capital controls over the past year to limit surging inflows.

Developing countries blame the U.S. Federal Reserve, in particular, as a fountain of excess capital because it is holding short-term interest rates near zero and pumping money into the economy by buying government bonds. "We oppose any guidelines, frameworks or ‘codes of conduct’ that attempt to constrain, directly or indirectly, policy responses of countries facing surges in volatile capital inflows," Brazil’s finance minister, Guido Mantega, told the IMF’s steering-committee meeting.

Mr. Mantega called capital controls "self-defense" measures. "Ironically, some of the countries that are responsible for the deepest crisis since the Great Depression, and have yet to solve their own problems, are eager to prescribe codes of conduct to the rest of the world, including to countries that are overburdened by the spillover effects of the policies adopted by them," he said in a statement to the policy committee.

Brazil’s economy is a great example of how US policy drives other nations to ruin as their government attempts to hold down inflation by raising interest rates but then those high rates attract hot money flows from around the World and pushes up the value of the Real.  Brazil’s Central Bank attempts to modify this effect by buying Dollars – forced to spend 1.4% of their GDP on this operation in 2010 alone – this is how the US strong-arms emerging markets into buying our debt!  

China is doing what they can with yet another round of tightening this morning and central bank Governor Zhou Xiaochuan said monetary tightening will continue for “some time.”  Reserve ratios will rise a half point from April 21, the People’s Bank of China said on its website yesterday, pushing the requirement to a record 20.5 percent for the biggest lenders. The move came less than two weeks after an interest-rate increase.  The nation’s fifth interest-rate increase since the financial crisis may come as soon as next month after inflation accelerated in March to the fastest pace since 2008. Chinese policy makers may also consider allowing faster appreciation in the yuan to reduce the cost of imported commodities.  

Over in Europe, Bundesbank President Axel Weber, who recently turned down an offer to head the ECB, said that European price pressures have increased significantly and that tighter monetary policy can be expected.  “We see a significant increase in inflationary pressure,” Weber said.  The euro region’s inflation rate of 2.7 percent in March, which followed a 2.4 percent reading in February, represents a “clear overshooting” of the ECB’s definition of price stability, according to Weber, who’s attending the Spring Meeting of the International Monetary Fund and the World Bank in Washington.  “If global price pressure continues — there have been few signs in IMF discussions that this will change over the rest of the year — one has to expect a further normalization of monetary policy in view of the price outlook.

The Euro continues to fall against the Dollar (now $1.43) on speculation that Greece will be unable to avoid a default.  The anti-Euro True Finns Party got 19% of the vote in this weekend’s elections and that will hinder regional efforts to assist ailing nations, including Portugal and Ireland. Greek bond yields surged to records.  “The latest developments in the euro region have a potential to provide hurdles for the Euro,” said Jane Foley, a senior currency strategist at Rabobank International in London. “The situation in Finland has to be monitored very closely, because it’s reflecting a trend in the political landscape of the region. There’s clearly fear among voters that they have to pay for fiscal mistakes of others.”    

The International Monetary Fund believes Greece’s debt is unsustainable and that the country’s government should consider a restructuring as early as next year, the Wall Street Journal said, citing three unidentified people familiar with the situation.  Senior IMF officials have told European Commission and euro-zone governments that a restructuring should be considered, the paper said. IMF, which hasn’t recommended a restructuring of all the country’s debt, has considered extending its loan repayment schedule, IMF spokesman William Murray told the paper.  

Euro-zone officials, including finance ministers, have said it is necessary to restructure Greece’s debt and the European Central Bank responded by saying it didn’t want a public discussion, an unidentified official familiar with the situation told WSJ.  A first step would be to substantially extend Greek bond maturities, another unidentified official said, according to the paper. That may include extending debt repayments by as much as 30 years, the official said.

Greece’s central bank chief said Monday that a restructuring of the country’s giant public debt would have "disastrous consequences," and called on the government to step up the pace of its reform program.  "[A debt restructuring] is neither necessary nor desirable," Bank of Greece governor George Provopoulos said.  "It would have disastrous consequences for the access of the government and of Greek enterprises to international financial markets, as well as very negative effects on the assets of pension funds, banks and individuals holding Greek government securities."

In May last year, Greece narrowly avoided default with the help of a €110 billion bailout from the European Union and International Monetary Fund. In exchange for that loan, Greece has committed to a multiyear austerity program to fix its public finances and overhaul its economy.  Since then the country has narrowed its budget gap by about a third, to around 10.6% of gross domestic product last year and is aiming to reduce it to 1% of GDP by 2015.  

But many analysts say Greece’s fiscal reforms aren’t enough to tackle a debt burden expected to reach nearly 160% of GDP in 2013. In recent weeks, there has been growing speculation that Greece will need to proceed with some sort of debt restructuring to ease that burden.  The central bank also sees inflation slowing to around 3.25% this year—down from an average rate of about 4.6% in 2010—but well above the government’s 2.2% forecast for 2011.

Early last year we discussed the "Ring of Fire" that represents the economies most likely to collapse under the weight of their debts.  Greece was, and is, clearly in the worst shape since, unlike the US, Japan and the UK – they were unable to print their way out of trouble but nothing has really changed on this chart other than a massive increase in debt that has moved the entire ring one giant step to the right.  I’m sorry if today’s discussion seems dull to some of you but this is how long this slow-motion collapse can be but, make no mistake about it, we are one by one being dragged over the cliff and it will quickly get worse if fiscally strong nations like Finland cut their ties to the debtor nations to avoid sharing their fate.

Oops – Speaking of which – the S&P just (9am) cut their debt outlook on the United States of America – now do you see why I’m so concerned?  

This will be interesting because that whacks the Dollar but is NOT good for the markets as rates rise (good for TBT) and is not good for oil or copper but is good for gold and silver and Japan will absolutely hate it too.  This should be good for our EDZ hedge as well so happy, happy, joy, joy for our disaster hedges this morning.  It may not be the disaster we expected but we’ll take it!  

Keep in mind things like this don’t all happen at once, today just happens to be a day that the S&P happens to mention that we are standing dangerously close to the ledge.  Brazil was much smaller than Greece when they defaulted in 1983 and they took the US economy down with them and Russia was forced to restructure their debt in February of 2000 and I don’t think I have to paint a chart of the Global markets that year to let you know how serious this can be.  

But we’re clearly not talking about just Greece here.  Most nations assume inflation will go down for the rest of the year while we at PSW have been pointing out that that is complete and utter BS.  Higher inflation means all interest rate projections are complete BS and, should growth slow as well – then that entire ring of fire takes a giant step down AND to the right yet again.  

World Bank President Robert Zoellick said the global economy is “one shock away” from a crisis in food supplies and prices.  The United Nations FAO Food Price index jumped 25 percent last year, the second-steepest increase since at least 1991, and surged to a record in February.  Food price inflation is “the biggest threat today to the world’s poor,” Zoellick said at a press conference following meetings of the World Bank and the International Monetary Fund. “We are one shock away from a full-blown crisis.”

Meanwhile, oil is still trading at $108.50 despite Saudi Arabia’s Oil Minister Ali al-Naimi said yesterday the “market is oversupplied.”  Saudi Arabia, the biggest oil exporter, has said it will make up for any crude production lost as a result of conflict in Libya, which erupted in mid-February. Saudi Arabia sold 2 million barrels of new blends of oil it has developed to help replace Libyan barrels withheld from the market, “and there is plenty left,” al-Naimi said as he arrived in Kuwait for a conference.

A decline in the price of crude certainly won’t solve all of our problems – but it would be a good start!  

 

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