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Currency

Euro rally: point, counterpoint and guesses

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Posted by Jack Crooks: Black Swan Capital

on Monday, 27 February 2012 09:09

It is said that markets discount the stuff we do know and run on the stuff we don’t.  Let’s take a look at what we do know, might know, and some best guesses about the future (called forecasts by “serious” analysts), as it relates to the rally in EUR/USD:  

1. Euro short rates relative to the US have turned higher again, i.e. the yield differential in favor of euro is improving.

Question: Will this continue?

Best Guess: I don’t think so because euro supply may begin to overwhelm demand (see #2 below).  And if US growth is for real, and a the 10 nation Eurozone recession is for real, one would expect US 3-month benchmark rates to drift higher relative to the euro.  

2. European Central Bank expected to flood banks with more credit next week; euro seemed to rally sharply on the last round of Long-term Refinancing Operations (LTRO) by the European Central Bank, i.e. three-year term loans to the European banking system.

Question:  Will we see the same type of rally in the periphery debt this time around?

Best Guess: Unlikely, in fact it might be a good time for those who bought last time to sell into the next round of ECB Long-term Refinancing Operations.  If so, if the EUR/USD rally shows signs of stalling next week, it could be time to start looking the other way.  

3. There is a lot of Fed jawboning about the potential for QE3.

Question: Is QE3 baked in the cake?

Best Guess: I don’t think so.  Two points here: 1) If the US recovery is for real, it doesn’t make sense that Fed Governors are so boisterous about the potential for QE3; and 2) Even Ben Bernanke (going out on limb here) has to understand that monetary policy stimulus has limits that become counterproductive at some stage and many, including me, think we are into the counterproductive territory.  Plus, how will QE3 that sits on US banks' balance sheets help any more than the pledge to hold Fed Funds rates low into 2014, in and of itself an incredible act by a central bank chief? It is what a rational person, assuming Ben is rationale, may ask himself.

Bottom line: Though the recent move in EUR/USD is powerful, I think it is a relatively near-term event. Here’s why:  1) If the US is really growing, the dollar at some point wins on growth and yield relative to euro.  Growth and yield are the intermediate-term drivers for currencies, and 2) if the US goes back into recession, a case we made in our latest Global Investor monthly issue; Europe goes into an even deeper one and China is in trouble too.  This means the US dollar, for all its warts, gets a big risk bid.  

We watch and see how reality plays out against our best guesses ... 

022412 eur

Captain of our fairy band,

Helena is here at hand,

And the youth, mistook by me,

Pleading for a lover's fee.

Shall we their fond pageant see?

Lord, what fools these mortals be!

        - A Midsummer Nights Dream Act 3, scene 2



Currency

How and Why China's Undertaking The Largest Gold-Accumulation Plan of All Time

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Posted by The Bullion Vault

on Friday, 24 February 2012 09:31

Since 1978, China has been exporting more goods than it has imported. That's allowed the nation to stockpile trillions of Dollars. What to do with so much money?

The way it works is simple to understand. When a Chinese business earns Dollars by selling overseas, the law requires the company to hand those Dollars over to the country's central bank, the People's Bank of China (PBOC). In return, the business gets Chinese currency (called either the "Yuan" or the "Renminbi") at a fixed rate.  
There's nothing fair about this. The Chinese people do all the work, and the Chinese government keeps all of the money. But that's the way it goes.

At first, the Dollar inflow was small because trade between the two countries was tiny. In 1980, for example, China's foreign currency reserves stood at approximately $2.5 billion. But since then, the amount of foreign currency reserves held by the Chinese government has gone up nearly every year...and now stands at $3.2 TRILLION. That's a 127,900% increase. It's simply astonishing to look at the chart of the increase in currency reserves... 

02232012 china gold

As I mentioned yesterday, the group in China that manages these foreign reserves is called the State Administration of Foreign Exchange (SAFE). This group is engaged in a full-fledged currency war with the United States. The ultimate goal – as the Chinese have publicly stated – is to create a new dominant world currency and dislodge the US Dollar from its current reserve role.

And for the past few years, SAFE has had one big problem, where to put the money.

SAFE decided to use most of these reserves to buy US government securities. As a result, the Chinese have now accumulated a massive pile of US government debt. In fact, about two-thirds of China's reserves remain invested in US Treasury bills, notes, and bonds. The next biggest chunk is in Euro. Of course, all this money is basically earning nothing to speak of in terms of interest...because interest rates around the world are close to zero.

And while the Chinese would love to diversify and ditch a significant portion of their US Dollar holdings, they are essentially stuck. You see, if the Chinese start selling large amounts of their US government bonds, it would push the value of those bonds (and their remaining holdings) way down. It would be like owning 10 houses on the same block in your neighborhood...and deciding to put five of them up for sale at the same time. Imagine how much that would depress the value of all the properties with so much for sale at one time.

One thing China tried to do in recent years was speculate in the US stock market. But that did not go well...The Chinese government bought large amounts of US equities just before the market began to crash in late 2007. It purchased a nearly 10% stake in the Blackstone Group (an investment firm)...and a similar stake in Morgan Stanley. Blackstone's shares are down about 46% since the middle of 2007, and Morgan Stanley is down about 70% since the Chinese purchase.

The Chinese authorities got burned big time by the US equities markets and received a lot of heat back home. They are not eager to return to the US stock market in a meaningful way. So China's US Dollar reserves just keep piling up in various forms of fixed income – US Treasury bonds, Fannie and Freddie mortgage bonds, and other forms of debt backed by the US government. These investments are considered totally safe – except that they're subject to the risk of inflation.  

According to a statement by the government: "SAFE will never be a speculator. It mainly seeks to protect the safety of China's foreign exchange reserves and ensure a stable investment return."
If the Chinese won't buy stocks and the only real risk to their existing portfolio is inflation, what do you think they will do to hedge that risk?  

They will Buy Gold...lots and lots of gold.

The Chinese are now clearly on a path to accumulate so much gold that one day soon, they will be able to restore the convertibility of their currency into a precious metal...just as they were able to do a century ago when the country was on the silver standard.  

The West wasn't kind to China back then. The country was repeatedly looted and humiliated by Russia, Japan, Britain, and the United States. But today, it is a different story...

Now, China is the fastest-growing country on Earth, with the largest cash reserves on the planet. And as befits a first-rate power, China's currency is on the path to being backed by gold.  

China desperately wants to return to its status as one of the world's great powers...with one of the world's great currencies. And China knows that in this day and age – when nearly all governments around the globe are printing massive amounts of currency backed by nothing but an empty promise – it can gain a huge advantage by backing its currency with a precious metal.  

As the great financial historian Richard Russell wrote recently: "China wants the Renminbi to be backed with a huge percentage of gold, thereby making the Renminbi the world's best and most trusted currency."  
I know this will all sound crazy to most folks. But most folks don't understand gold, or why it represents real, timeless wealth. The Chinese do.

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Currency

130 billion bad reasons to be careful

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Posted by Jack Crooks: Black Swan Capital

on Tuesday, 21 February 2012 09:34

“So what?” he asked. “Things will only get worse. We have reached a point where we’re trying to figure out how to survive just the next day, let alone the next 10 days, the next month, the next year.”  

-Anastasis Chrisopoulos, Athens taxi driver (from Reuters)

130-billion-euro here, 130-billion-euro there, and pretty soon you have to start finding some growth!

One adage that seems to work as much as anything else, and why it is an adage I guess, is “buy the rumor and sell the news.”  I won’t bore you with the behavioral aspects of why this works, I think you know.  We are seeing it a bit this morning on display on news a Greek default has been averted: the euro is lower, and ditto for most Eurozone bonds since the announcement of a deal that gives Greece another 130-billion-euro it can pour down the rabbit hole with the rest of the money funneled in by Eurozone taxpayers.   

Of course, sooner or later financial engineering reaches the limits of its public relations effect and there must be some underlying payoff from said engineering besides getting funds to follow banks chasing into periphery debt for a trade.  It’s not that rising periphery bond prices, i.e. lower yields, isn’t helpful; it is.  But even at current rate levels, it will be mighty hard for many countries to maintain austerity pledges; all attempts to do so will likely accentuate the trend we see in the chart below:      

022112 ez gdp

And of course, this chart is the mirror image of the domestic adjustments periphery countries have to make because they do not have a free-floating currency available to help them make these adjustments:    

022112 ez unemployment

Thus, periphery economies desperately need some growth.  Rising unemployment and tighter budgets will not produce revenues needed to pay debt; instead it produces a self-feeing vicious spiral downward.  This view seems completely at odds with the Troika program even though the Greek economy provides them with live test case of abject failure stemming directly from the implementation of their own flawed theories.     

And here is why it will likely get worse for Greece and other periphery countries whose growth is heading lower—the real economy will be starved.   

We have already witnessed this economic/money/manipulation phenomenon in the US, from the WSJ this morning:  

“The eight giant European banks that have disclosed their annual results in recent weeks reported holding a total of about $816 billion in cash and deposits at central banks as of Dec. 31.  That is up 50% from a year earlier, when the same banks were holding roughly $543 billion.”  

Does any of this sound familiar?  You can lead a horse to water, in fact you can force-feed said horse with massive amounts of reserves, but you can’t make him lend any of it to the real economy where real people build real businesses and hire other real people who need real jobs.   

Just in case you forgot just how tightly US banks have held on to their Fed sponsored reserves via the massively steep yield curve that impoverishes savers to subsidize bank healing, here is a look.  This chart shows reserves in the US banking system ... hmmm ... three years and counting so far since Bernanke and Company decided this is the only viable strategy for the economy.  Viable for financial assets, but the other side of the economy is still starved ... 

022112 fed reserves

The point is, despite the new Greek rescue (I am losing count how many we have had so far), it appears the Eurozone, now clearly a two-track world with Germany bathing in credit and low rates and low unemployment (which adds to more angst and animosity toward Germans amongst the PIIGS), appears collectively heading into deeper recession.  

One wonders if now, finally, EU leaders have run out of rabbits of financial engineering to pull from their hats.  Financial engineering is a lot easier than real growth.  If you don’t believe me, go ask Goldman; after all it is their fun and games that caused much of this Greek problem in the first place.  

022112 eur vs gdp

Hmmm ...



Currency

7 reasons why the Chinese are Paper Tigers

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Posted by Jack Crooks - Black Swan Capital

on Monday, 20 February 2012 04:24

A theme being discussed more and more is the idea China is going to save us from the monetary mess in which we are now firmly ensconced.  But based on my understanding, it will likely be several decades, if ever, before the Chinese currency seriously challenges the US dollar for global reserve currency status.

“Be extremely subtle, even to the point of formlessness. Be extremely mysterious, even to the point of soundlessness. Thereby you can be the director of the opponent's fate.” - Sun Tzu

Screen shot 2012-02-17 at 3.20.47 PM

However, it is not to say there won’t be a different global monetary solution in the years ahead.  It will depend on whether or not there is a repudiation of US debt.  If so, I think some new order will take place, along the lines of what Keynes’ talked about -- the Bancor.  He knew early on the dangers attached to a dominant world reserve currency.  [Mr. Triffin, aka ofTriffin’s dilemma fame, warned the US would be facing structural current account deficits as far as the eye could see in its role of world currency reserve supplier.]  Thus, these two were very aware of the danger of global imbalances before it became popular in this cycle. The Great Depression was a valuable teacher for them.  

Of course history tells us global monetary systems are more haphazardly morphing events than they are planned occurrences.  All we have to do is watch the G-20 to see how difficult serious, multi-global planning can be; heck, those guys can hardly decide on what wine to serve and the order of photo ops.   

The handoff from pound Sterling to the US dollar was an unplanned evolving event that accelerated after WWI.  There was no great planning when President Richard Nixon took us off the gold standard and ushered in the error of floating rate currencies.  The gold was draining out of Fort Knox, something had to be done.  Game over.  Dirty float for a couple of years, then no pretense whatsoever of anything backing the currencies of the world’s major powers.  Just faith!  No pretense was justifiable; from that point onward money was a store of value.  Purely a unit of exchange it became.  Case closed.  

So, it leaves us where we are, as I shared with you yesterday, thanks to the excellent insight from Professor Barry Eichengreen.  Now I think it is time to explode the myth China’s currency will replace the dollar.  Many newsletter writers think that will happen tomorrow.  Proving once again newsletter writers never have to answer for their inflated farcicality. But even some serious people believe within the next decade China’s currency will rule.  I think even some serious people are wrong.  

Rather than turn this into a LONG essay, I will try to breakdown the reasons why I think the Chinese yuan is a very long way from world reserve currency status:

  1. It is never as simple as “the world reserve currency goes to the country with the largest global GDP.”  The US surpassed the UK in terms of total GDP back in the 1870s.  Yet pound Sterling remained the reserve currency for another 40 years or so. 

  2. Remember, the world reserve currency country is saddled with a consistent current account deficit. Thus, China must push out trillions of renminbi and renminbi-based asssets into the world economy.  Fine if your model is open and based on consumption.  Not so good if it is driven primarily by exports, as China’s is.  So we will need to see a big shift in China’s growth model.  That will be a wrenching long-term process.

  3. The reserve currency country must open its market to allow foreign investors to hold local assets.  This means China will have to make a complete change to its current political structure to allow much more freedoms for citizens (not only allow money to flow in, but allow its citizens money to flow out freely).  The system in place is not something that is likely to change anytime soon despite the window dressing.  The communist party still maintains absolute power, despite the comments from visitors that all they saw was free market capitalism during their trip to the Orwellian Hall of Mirrors.  It shows just how well the central committee is doing its job.  If you want a better insight into this issue, I strongly suggest you read, The Party: The Secret World of China’s Communist Rulers, by Richard McGregor.  I think this does a great job of showing us how the West in general is duped by the Chinese leadership.

  4. The US is becoming wealthier relative to China.  Say what?  All true.  The fact is since 1991, “the average Chinese citizen is more than $17,000 poorer relative to the average American than he was in 1991.” Per capita income for relatively large states is the best single determinant of competitiveness long term. So, until this trend changes, it is highly unlikely the US will give up the mantle of currency reserve status.  [See “China’s Century?” by Michael Beckley, International Security, Vol. 36, No. 3 (Winter 2011/12), pp. 41-78.   

  5. Even optimistic assumptions from those who should know, assuming China’s growth remains on track, suggest by 2035 up to 12% of global reserves may be held in yuan. [See Jong-Wah Lee, Asian Development Bank, “Will the Renminbi Emerge as an International Reserve Currency?”]

  6. Officially, all is good.  But unofficially, China may be facing its own debt bomb that could dampen growth for years, not just one or two quarters.  It happened to Japan.  Never say never! “The government’s official debt is only 15 percent of GDP, but it adds up quickly. Ratings agency Fitch estimates a bailout could cost 20 percent of GDP. Add the unpaid cost of the last bailout, debts at state-owned entities, local governments and pension liabilities, and a Breakingviewscalculation suggests Beijing’s debt rises to roughly 130 percent of GDP,” according to Reuters Breakingview. 

  7. The current attempts at internationalization of the yuan seem backwards.  Normally a country opens its capital account and upgrades its domestic financial system before attempting to internationalize its currency.  Instead China is offering bi-lateral exchange deals with some trade partners, and that gets a lot of press.  But that seems to be mere window dressing as countries are really taking up the credit China is offering.  And the developing offshore yuan deposits in Hong Kong may actually backfire, as the unofficial yuan rate in Hong Kong (CNH) is fluctuatiing around the official rate in China (CNY).  This may force China’s central bank to actually hold more dollars. 

So as much as it might be a good thing for the global economy to have a new reserve currency on the scene, it doesn’t seem as if it will happen soon enough to help in this cycle. 

 
By Jack Crooks of Black Swan Trading


Currency

Richard Russell: Austerity or Inflation

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Posted by King World News

on Tuesday, 14 February 2012 02:24

gold-dollar-sign

With investors globally wondering what central planners are up to next and how it will impact gold, today the Godfather of newsletter writers, Richard Russell, was discussing this very subject:  “A few months ago I wrote a piece about avoiding pain in the economy.  How do we do it?  We do it by turning away from austerity and embracing inflation.  And the question -- will the inflationary method of avoiding economic pain kill our economy, just as the drug (taking drugs) way of avoiding pain has killed so many talented musicians?  I think the results will be the same.”

Richard Russell continues:

“The world has drunk at the punch-bowl of good times and debt ever since World War II.  The world has avoided the discipline of pay-as-you-go and austerity for decades.  But sooner or later the piper must be paid.  Up to now, the piper has been ‘paid’ with vast amounts of fiat paper.

The politicians want to make the people happy.  The Fed is beholden to the politicians.  The voters want it all, and they don't like pain.  The Fed and the politicians want to make the voting public fat and happy causing as little pain as possible.

Examples: courtesy of Bill Gary's great publication, ‘Price Perceptions.’

Last week the Fed announced that they were extending the current near-zero interest rates out to the end of 2014.

The European central bank gave in and finally reduced interest rates to 1%.

The Bank of England is meeting next week to decide on another round of QE. (money printing).

This week the Bank of Australia will decide on whether to reduce rates again. 

The Swiss National Bank placed a currency floor of 1.2 francs per euro in September to prevent further strengthening of the franc.

Japan has been printing for years in an effort to keep the yen cheap and competitive against other currencies.

Every nation wants a cheap and export-friendly currency.  The result is a blizzard of (fiat) paper money blowing across the face of the earth.

Inflation is the central banks' method of avoiding the pain of austerity.  Inflation is the current economic narcotic that is used by modern nations.  It's the old ‘beggar thy neighbor’ system, and it will ultimately result either in all out hyperinflation and a collapse of the fiat currency system or a corrective deflationary crash.  Either way, the last currency standing will be gold.”

To subscribe to Richard Russell’s Dow Theory Letters CLICK HERE. 



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