Monday, August 07, 2006

The USD Devaluation Policy Option

EUR/USD 1.2865 / 68 Hi 1.2895 Low 1.2850
USD/JPY 114.85 / 89 Hi 115.07 Low 114.15
AUD/USD 0.7636 / 40 Hi 0.7671 Low 0.7626
EUR/JPY 147.79 / 83 Hi 147.90 Low 147.03

Well the U.N. has managed to come up with a document which pleases no-one. Given that there is a war under way, that is hardly surprising. The next couple of days will be interesting: we have the U.N. vote on the draft resolution which calls for a cease-fire (sort of) in Lebanon and the FED will meet to decide whether they should start planning for the up-coming U.S. recession. And the talk of a likely recession in the U.S. is starting to become more insistent. The data certainly isn't inspiring. More economic weakness is expected as the slowdown in the U.S. housing market starts to impact growth right across the board. Employment numbers released Friday helped complete the picture, but the prognosis remains the same: economic growth in the States is under strain. The cost of financing a huge military campaign in Iraq and Afghanistan, the burden of higher OIL and commodity prices, and the rising cost of financing the massive level of accumulated household debt are all weighing on economic activity. And no improvement is likely in the short to medium term.

The USD has seen some fall-out from Friday's poor NFP figures, but nothing spectacular. Established ranges are pretty much holding. The focus is on the August 8 FED decision. Should the FED hit the PAUSE button, the thinking is that this will be the nail in the USD coffin. Maybe, maybe not. There aren't a lot of countries out there which are keen to see the USD fall through the floor. Beggar-thy-neighbour currency devaluations are not exactly welcome. And even the U.S. has a lot riding on its "Strong Dollar" policy, which Treasury Secretary Paulson just took out off the shelf and dusted down. (Hey it worked for Rubin). The U.S. needs foreign capital inflows to keep coming, and a policy of devaluation wouldn't really inspire a lot of foreign investors to buy DOLLARS. So any devaluation will have to be managed with the utmost stealth, if a devaluation can be managed at all.

Without a USD devaluation (which would effectively export the U.S. economic slowdown to the rest of the world) the U.S. will just have to wear the economic pain. This would mean range trading on FOREX MARKETS would continue as the U.S. acts to hold its currency as steady as is possible. The real action would be on Stock Markets. So far the USD is holding. The risks are huge. It is not a given that the U.S. will be able to hold the dollar, but clearly that is their intention. Which will make this week's FED POLICY MEETING even more interesting.

Global Stock Markets don't like any of this. The Japanese Nikkei closed down 2.23 % and is now down nearly 6 % for 2006 as a whole. Europe is down on the day, up marginally YTD and worrying about more rate hikes and the U.S. economic slowdown. In the U.S. the outlook for Stocks isn't good. Bernanke may be able to save the day Tuesday, but it doesn't look likely that he will be able to save the economy over the medium term. The debt-financed consumer-fest which drove the U.S. expansion is over and there are no other likely sources of growth out there, if you scratch a major USD devaluation off your list of possible policy strategies. So the outlook for profits and stocks is dim, at best.

Oil 76.66
Gold 660.00

GEOPOLITICS and the failing international confidence in the USD has lit a fire under GOLD, which doesn't look like it will go away any time soon. There are, though, forces at work. Oh yeah. So let's welcome the next shadowy, behind-the-scenes team working to keep markets orderly: Goldman Sachs. I doubt there is anyone in the market who doesn't think Goldman is part of the Plunge Protection Team. But the PPT sure has a lot of balls in the air right now: propping up the USD, working to STOP GOLD re-emerging as the Global Reserve of choice, trying to contain the rally in OIL (or maybe not - after all the Neo-Cons have well-established links with the OIL industry). At any rate there is a new story about market manipulation making the rounds and this time the target is GOLD . Having an ex-Goldman Sachs executive as your Treasury Secretary obviously has all kinds of advantages. Provided, of course, that the market buys your spin. So, depending on who you listen to, GOLD could be in for a (manipulated) multi-week correction in the short term or it is on track for USD 900 in the medium term. Or both.

If you join all the dots: a likely sustained devaluation of the USD over the medium to longer term (that is if we don't actually see a major rout in the currency in the short term), rising inflationary pressure linked to excessively loose monetary policy pretty much around the globe and ugly GEOPOLITICS then you would have to take any downward move in the price of GOLD (manipulated or not) as an opportunity to buy. We are not so much talking an opportunity to make speculative gains but an opportunity to preserve wealth in what looks likely to be a major readjustment in Global Financial Markets. PPT or no PPT.

And now for the good news: BP Plc has been forced to close its Alaskan pipe line. And, guess what, OIL is up some more. So far there have been no credible rumours about the price of OIL being manipulated (but hey watch this space). And the overwhelming consensus now appears to be that the target for OIL is USD 100. Look on the bright side, that is an increase of only 30 percent and we have already seen the price of CRUDE more than triple, so we are talking pretty small bananas.

That said: how much would the Bush Administration benefit from this timely combination:

  • a positive resolution of the conflict of Lebanon
  • the reopening of the Alaskan OIL Pipeline and subsequent fall in the price of CRUDE and
  • a FED PAUSE.

  • I don't know how likely it is that they can pull off that kind of hat trick. But if you were out to manipulate the market, that would certainly be the time to act. Remember there are elections due November 7 in the States and the Bush Administration badly needs to score some goals before then. It's a dicey game to play, but if the people behind the PPT are really as arrogant as some commentators suggest, then maybe they figure that Manipulating the Market will be a slam dunk their favour.

    If the GOLD market defies market manipulation, then be careful if you are holding USDs.

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