Gary Dorsch (
Global Money Trends
) submits:
Everything depends on proper listening. Of ten people who listen to
the same speech or story, each person may well understand it
differently. Perhaps, only one of them will understand it
correctly.
How should traders interpret the latest remarks by US Treasury
chief Timothy Geithner, who shocked the currency markets on October
18th, citing his determination to defend the value of the
US-dollar?
Geithner was asked in a question and answer forum, "Are you
concerned with all of the money being printed over the last couple
of years? Are we on our way to debasing the value of the dollar?"
Geithner surprised his audience with a passionate defense of the
US-dollar.
He said:
Not going to happen in this country. It is very important for
people to understand that the United States of America and no
country around the world can devalue its way to prosperity and
competitiveness.
It is not a viable feasible strategy and we will not engage in
it. It is very important that people have confidence in our
capacity to meet our long-term fiscal obligations, to make sure
the Federal Reserve does its job of keeping inflation low and
safe over time. And we recognize that the US plays a particularly
important special role in the international financial system,
because the US-dollar serves as the principal reserve asset of
the global financial system. So we're going to work very hard to
make sure that we preserve confidence in the strong dollar.
Yet just a few days earlier during a much-anticipated speech on
October 15th,Fed chief Ben "Bubbles" Bernanke broadly hinted that
he favored an early resumption of "quantitative easing" (QE-2),
knocking the US-dollar into a tailspin.
Bernanke declared:
Inflation is running at rates that are too low relative to the
levels that the Committee judges to be most consistent with the
Fed's dual mandate in the longer run. There would appear, all
things being equal, to be a case for further action.
Bernanke took the highly unusual step of making it clear that
the Fed's policy going forward would be to raise the rate of
inflation to 2% by means of massive money printing. Bernanke tried
to brainwash the American public into believing that QE-2 will
significantly bring down the jobless rate. Bernanke's support for
QE-2 helped the Dow Jones Industrials index to soar above 11,100,
despite further losses in US-payrolls, and a jump in the
under-employment (U-6) jobless rate to 17.1%.
click to enlarge
Bernanke knew that simply hinting at QE-2 would spark a further
sell-off of US-dollars. After Bernanke spoke, the Australian dollar
reached parity against the US-dollar for the first time since it
was freely floated in 1983. The US$ also fell to parity with the
Canadian dollar, and hit new all-time lows against the Swiss franc,
and a 15-year low against Japan's yen. Brazil's real, Chile's peso,
the Korean won, and the Indian rupee rose versus the US-dollar.
Gold hit a new record high, and commodities such as crude oil,
copper, corn, cotton, cattle, soybeans, platinum, palladium,
rubber, and silver all continued their upward spiral.
After Geithner's remarks, the Euro quickly found resistance at
$1.400, and began to sink to $1.3935 within a few minutes. The
Aussie dollar dropped 0.80-cents to 98.50-cents, before getting
blasted again a few hours later after China's central bank shocked
the markets by lifting its one-year loan rate a quarter-point to
5.56%, its first rate hike in 3-years, knocking industrial
commodities lower. The Aussie plummeted towards 96.50-cents a few
hours later, before regaining its footing. The Euro's slide came to
a halt at $1.3700, where sidelined buyers emerged.
However, 24-hours later, the impact of Geithner's remarks and
China's surprise rate hike had already dissipated into thin air.
The Aussie dollar - a symbol of risk taking - rebounded strongly to
98.75-cents, and the Euro recovered to $1.3950. The US-dollar
skidded to 81-yen, despite threats by the Bank of Japan a few hours
earlier to expand its own version of QE-3 beyond the 5-trillion yen
of JGB buying pledged earlier. Once again, traders resumed their
betting on "Bubbles" Bernanke and a massive tidal wave of QE-2
starting after Nov 3rd that would trump the efforts of other
central banks to prevent the US-dollar's downfall.
A few hours later, Geithner stepped-up his verbal rhetoric by
telling the Wall Street Journal on October 20th there's no need for
the US-dollar to sink further against the Euro and the yen, saying
these currencies are "roughly in alignment" now. He emphasized that
the US-Treasury isn't trying to devalue the US-dollar, echoing
comments he made in Palo Alto, California. Geithner appeared to
offer a secret gentleman's agreement with Beijing to stop the
currency war if the pace of the Chinese yuan's appreciation against
the US-dollar since September is sustained, to correct its
undervaluation.
If China knew that if it moved more rapidly, other emerging
markets would move with them, it would be easier for them to
move.
.
In early September, the US Treasury's 5-year note yielded
+25-basis points more than German 5-year yields. Today, the
US-Treasury's 5-year note yields -53-bps less. The US-dollar's
allure as a "safe haven" currency has also crumbled, as tensions
surrounding the Greek bond market continue to subside. Credit
default swap (CDSs) rates, measuring the odds that Athens would
default on its debts, have dropped in half over the past
four-months to around 650-basis points today.
The US Treasury has sought to gain extra leverage from the
dollar's slide by seeking to corral the support of other G-20
central bankers and finance ministers behind its drive to
strong-arm China into more rapidly and sharply rising yuan. With
the dollar down 12% against the Japanese yen since mid-June,
compared with less than 3% versus the Chinese yuan, sparks began
fly. Tokyo denounced Beijing for bidding up the yen by increasing
its purchases of Japanese government notes.
Since Beijing scrapped a 23-month-old peg to the dollar on
June 19th, and said it would let the yuan resume a managed
"dirty" float, the yuan has appreciated +2.8% against the
US-dollar, but weakened 10% against the Euro.
Eurozone finance chief Jean-Claude Juncker said:
It is much worse against the Euro than the US-dollar - this is not
a good situation. It contributes to global imbalances. We want
China to assume its responsibilities as a global player.
Beijing intervenes regularly in its foreign exchange market to
rig the value of the yuan, and it's acquired a massive
$2.65-trillion in FX reserves, while keeping the Chinese yuan
undervalued by 40% against the US-dollar, on a trade weighted
basis. Democrats and Republicans in the US-Congress aren't willing
to wait for Beijing to revalue the yuan at a snail's pace over the
next several years. In Hong Kong, the 12-month yuan forward
contract is trading at 6.4425 /dollar indicating that traders
figure that Beijing would only allow the yuan to rise by a paltry
+3.2% rise against the dollar over the next 12-months.
Instead, US-lawmakers aim to level the playing filed in one fell
swoop. On Sept 29th, the US-House passed legislation by an
overwhelming margin, 348-79, to allow the Commerce department to
apply tariffs on Chinese goods entering the United States. In the
past, the Senate has pushed for tariffs of 25% on Chinese
imports.
Republican Senator Richard Shelby of Alabama said:
There is no question that China manipulates its currency in
order to subsidize Chinese exports. The only question is: Why is
the administration protecting China by refusing to designate it
as a currency manipulator?
On October 16th, Treasury chief Geithner backed away from a
showdown with Beijing over the value of the yuan, by delaying a
much-anticipated decision on whether to label China as a currency
manipulator until after the Group-of-20 summit on November
11th.
The Treasury said:
Since September 2, 2010, the pace of the yuan's appreciation
has accelerated to a rate of more than 1% per month. If sustained
over time, this would correct a significantly undervalued
currency.
an acknowledgment of the faster pace of the yuan's
appreciation and we'd like to see that sustained. What we know
now is that it's significantly undervalued, which I think they
acknowledge and it's better for them, and of course, very
important for us, that it move. And I think it's going to
continue to move.
Bank of England Mervyn King warned that the prospect of a trade
war over global imbalances could spark a 1930's-style economic
collapse.
The need to act in the collective interest has yet to be
recognized, and, unless it is, it will be only a matter of time
before one or more countries resort to trade protectionism as the
only domestic instrument to support a necessary rebalancing. That
could, as it did in the 1930's, lead to a disastrous collapse in
activity around the world. Every country would suffer ruinous
consequences -- including our own.
Chinese - Indian Central banks fear Commodity
Inflation
A stronger yuan is in China's best interest, since it can be
utilized to shield the world's biggest buyer of commodities from
the sting of sharply higher import prices. Since Beijing un-hinged
the tightly pegged US$-yuan peg, and the Fed began sending signals
about unleashing of QE-2, the Continuous Commodity Index ((
CCI
)) - an equally weighted index of 17 different commodity futures,
has rallied by 23% to its highest level in two-years. Coffee,
cotton, corn, cattle, gold, silver, platinum, soybeans, and wheat
have been the stellar performers, with crude oil lagging behind.
Other key industrial commodities not included in the index which
have skyrocketed are tin, rubber, nickel, and palladium.
Efforts by the Fed to weaken the US-dollar by threatening to
unleash QE-2 have led to sharply higher commodity prices, and is
pushing-up China's inflation rate to +3.5%. There are also bubbles
brewing in Chinese property prices and renewed interest in Shanghai
red-chips. Against this backdrop, the Fed and the US-Treasury have
exerted considerable pressure on Beijing to allow the yuan to rise.
The People's Bank of China (PBoC) finds it difficult to lift
interest rates to combat inflation, because a widening in the
Chinese yield spread over US Treasuries would only suck in more
"hot-money" into the Chinese yuan.
But on October 19th, the PBoC surprised the markets with its
first interest rate hike in three years, taking one-year lending
rates 0.25% higher to 5.56-percent. The rate hike follows on the
heels of the PBoC's decision to lift reserve requirements by a
half-point to 17.5% at six Chinese banks last week, draining
200-billion yuan out of the Shanghai money markets. Commodity
traders are beginning to wonder if Beijing has just started to
roll-out a longer-term tightening campaign.
The Reserve Bank of India ((RBI)) has also been forced to
tighten its monetary policy to fend off commodity inspired
inflation by lifting its repo rate on five occasions this year to
6-percent.India's wholesale inflation rate is +8.5% higher than a
year ago, and is far above the RBI's perceived tolerance level of
around 5%, keeping the inflation adjusted interest rate stuck in
negative territory.India's economy is on track to grow at 8.5% this
year, lagging only China, so the RBI could be forced to hike its
repo rate several more times if commodities continue to spiral
higher under the magic carpet ride of the Bernanke's QE-2.
Soaring Copper, QE-2, Rising Interest rates Lift Chile's
Peso
Chile is among a number of emerging economies, including Brazil,
India, Thailand, Korea, and South Africa, whose currencies have
risen sharply against the Chinese yuan and US-dollar. They're
rising from an influx of foreign capital seeking higher returns
than are available in England, Japan, and the US, where interest
rates are hovering near zero-percent. Capital is flooding into
emerging markets and could lead to excessive exchange-rate moves,
asset bubbles and financial instability, warned IMF chief Dominique
Strauss-Kahn on October 18th.
Many of these emerging countries are intervening repeatedly in
the currency markets to hold down the value of their currency
against the US-dollar, and by default -the Chinese yuan.
Brazilian Finance Minister Guido Mantega warned on October
9th:
Near-zero interest rates and rapid monetary expansion are
geared at stimulating domestic demand but also tend to produce a
weakening of their currencies. As a result, emerging countries
will continue to build up reserves in foreign currency to avoid
volatility and appreciation.
Traders are pouring vast sums of capital into the emerging stock
markets, forcing-up the exchange rate of emerging currencies and
inflating asset bubbles. The
MSCI Emerging Markets Index has soared +13% since the start of
September. The US-dollar has tumbled -14% against the Chilean peso
since the beginning of July due to fears of QE-2. Chile's peso is
also gaining support from soaring copper prices, which reached a
2-year high of $8,400 /ton in London. Chile posted economic growth
of +6.5% in the second quarter, helped by inflated copper prices,
which are linked to a staggering 40% of the country's total
economic output.
Banco-de-Chile chief Jose De Gregorio is utilizing the direction
of copper as a real-time indicator to gauge the forward momentum of
the local economy. In sync with higher copper prices, Chile's
central bank has guided its overnight loan rate higher by 225-basis
points to 2.75% last week. In turn, the steady increase in Chile's
interest rates has widened the gap with US-Treasuries, and has
attracted foreign capital, putting upward pressure on the Chilean
peso.
Chile 's finance chief Felipe Larrain says,
Both China and US are at fault in the currency war. Although
the currency tension seems to be a dispute just between
Washington and Beijing, its implications go well beyond the two
countries. If exchange rate variability between the yuan and the
US-dollar is very little, the US-currency will likely depreciate
against currencies of emerging markets. Developed but
fast-growing economies, like Korea and Australia, in turn, will
also face great appreciation pressure on their currencies.
Brazil
Locked in Tough fight with Currency traders
Brazil 's ministry of finance (MoF) is locked in a bitter
struggle with traders over the value of its currency - the Real -
in a battle that requires unorthodox techniques. The MoF is
desperately trying to halt the appreciation of the real, which has
more than doubled in value against the US-dollar since President
Lula da Silva took office in 2003. It's now a darling of foreign
investors. Yet, what was once seen as a blessing has become a
curse. From January until August, Brazil's trade surplus was
whittled down to $11.6-billion or 41% less than in the same period
a year earlier. Finance chief Guido Mantega warned he'll take
whatever measures are necessary to keep the real from further
eroding Brazil's trade surplus.
The Bank of Brazil has resorted to multiple interventions in the
currency market to prevent the real from climbing higher. Brazil's
foreign exchange stash now exceeds $250-billion, with $165-billion
parked in US-Treasuries. However, the combination of Brazil's
robust economy and the world's highest interest rate at 10.75% has
made the real an irresistible target for foreign traders at a time
when Japanese and US bonds are saturated with excess liquidity and
ultra-low yields.
Brazil has one of the most advanced industrial sectors in Latin
America, accounting for roughly one-third of the GDP. It's also
a major supplier of commodities and natural resources, with
significant operations in iron-ore, tin, sugarcane, coffee,
tropical fruits, orange juice, corn, cotton, cocoa, tobacco, and
forest products. Brazil has the world's largest commercial cattle
herd, and it's the world's #2 grower of soybeans and #1 exporter of
ethanol, which are all soaring thanks to QE-2.
Brazil should begin to reap bigger trade surpluses in the months
ahead, as the latest upward thrust in global commodity prices
filters into its economy. Currency dealers are tracking commodity
prices, lifting the real briefly above 60-US-cents last week.
Finance chief Mantega says Brazil is engaged in a "currency war"
with Bernanke's Fed, and has "a lot of ammunition" such as boosting
taxes on foreign investment in Brazilian fixed income. Mantega
criticized the Fed for "considering more quantitative easing. It
won't reactivate the US-economy, but it will weaken the
US-dollar."
On October 18th, Brazil hiked taxes on foreign investment in
fixed-income bonds to 6%, and also closed a loophole that allows
speculators to avoid the tax on margin deposits for transactions in
futures markets. The higher taxes will only affect new flows of
money into the bond market, not deposits already in Brazil. "This
currency war needs to be deactivated," Mantega said.
Beijing takes aim at Shanghai Gold
China's central bank (PBoC) surprised traders on October 19th
with its first hike in bank deposit rates in three years,
reflecting its concern about rising asset prices and stubbornly
high inflation. The PBoC guided 1-year bank deposit rates higher by
25-basis points, to 2.50%, and triggered a 3% drop in the Shanghai
gold market.Once a consensus has been forged in Beijing to raise or
cut rates, past experience shows that the PBoC moves in a series of
adjustments.
To date, the PBoC has relied on slowing down bank lending and
lifting banks' reserve requirements to keep the growth of the M2
money supply from boiling over. Still, China's Treasury yields
rates are too low for an economy that's growing at a +10% clip. The
real rate of interest on China's Treasury notes is buried in
negative territory - yielding less than the official 3.6% rate of
inflation. Negative interest rates are whetting the appetite of
Chinese traders in gold, silver, and base metals.The Shanghai stock
index, a laggard this year, has jumped +16% in the past nine
trading days, led by banks and commodity related companies.
The PBoC's rate hiked jolted the yield on China's 5-year T-note
out of its summer slumber, lifting it upwards by 30-basis points to
as high as 3.05% on October 19th. In a knee-jerk reaction, Shanghai
gold fell 3% to as low as 8,850-yuan /oz, where an upward sloping
trend-line resides. Buyers emerged from the sidelines on ideas that
negative interest rates in China would continue to fuel gold's
historic rally.
Li Daokui, an adviser to the People's Bank of China, said on
October 19th,
The interest rate rise will make people feel safe and prevent
them from taking out their money from bank deposits to invest in
stocks or property market.
However, gold traders and speculators in Shanghai red-chips
disagree. The amount of cash sitting in China 's bank deposits
increased by 1-trillion yuan ($156-billion) in September to
30-trillion yuan, and could lend plenty of firepower for the
Shanghai gold market.
However, on October 20th, China's central bank continued to
exert upward pressure on short-term Treasury yields by draining
145-billion yuan ($21.8-billion) from the Shanghai money markets
through 91-day reverse repos. The PBOC also mopped-up 50-billion
yuan by selling one-year T-bills.
However, there are other channels that can keep the gold market
buoyant. The Value Gold ETF is expected to be launched on the Hong
Kong Stock Exchange in early November, with the underlying physical
gold held at Hong Kong's Precious Metals Depository. The Gold ETF
could attract a whole new wave of wealthy investors to the yellow
metal since the Hong Kong Monetary Authority pegs its overnight
loan rate at a miniscule 0.50%, in order to keep the HK-dollar
fixed to the US$.
Is Mr. Geithner going to make good on his vow to defend the
US-dollar? He'll need to convince the radical inflationists at the
Bernanke Fed to mend their foolish ways, and follow the blueprints
of the European Central Bank ((ECB)). Having bought 16.5-billion
Euros of Greek, Irish, and Portuguese bonds in the second week of
May, the ECB's purchases of bonds slowed to a trickle by early
August, winding down its sterilized QE scheme at 63.5-billion
Euros. The three-month Euro Libor rate climbed above 1% this week,
a signal that the ECB is slowly withdrawing liquidity.
We need to make the right decision for the longer horizon. And
if the right decision means we disappoint markets, then that
might be short-run painful, but is the right long-run
decision.
However, Bernanke's inflationists out-number the Fed hawks, and
the world economy should brace itself for a round of
hyper-inflation.
Disclosure:
Long [[DGP]]
See also
Concern Over Europe: The Dominant Factor Driving
Recent Market Swings
on seekingalpha.com