Thursday, November 30, 2006

Prepare for Game Over

EUR/USD 1.3201 Hi 1.3211 Low 1.3141
USD/JPY 116.12 Hi 116.58 Low 115.96
AUD/USD 0.7876 Hi 0.7883 Low 0.7822
EUR/JPY 153.33 Hi 153.48 Low 152.89

Well they wheeled out mild old Ben Bernanke and he made ALL the right noises. The furious financial market speculation about the U.S. economy falling into a black hole was put to rest. Well not really. Bernanke basically made the case that a FED EASE was not yet a slam dunk. Inflation is still lurking. And with this carefully timed, carefully worded sound bite Bernanke saved the USD. Well not really. But the USD plunge sort of stalled. After all the PPT is back from their Thanksgiving break and the Europeans are not happy to see the Euro breaking up all over the place. French officials have been making distressed noises. No reports so far of more than jaw boning by the Europeans though the ECB has a role to play in smoothing the USD descent. So the USD is still in trouble but not losing ground at the speed of light. For now.

Hey so let’s all cheer. Although the data still looks pretty bad: Durable Goods numbers were terrible, the Residential Housing market is reminiscent of what happened to Japanese real estate when the bubble burst in the early 1990s, only worse. At that point the Japanese were sitting on a pile of domestic savings and the country as a whole was paying its way in the wider world. The case in the U.S.A. is slightly different and George W. is still madly fighting costly wars in far away lands.

U.S. GDP numbers were revised up for Q3, not because domestic demand was any stronger than first reported. No, the reprise seems to have something to do with Inventories and Imports. Great. The debt bubble collapse continues. Though you wouldn’t know it if you listened to the Talking Heads from Officialdom.

The ugly facts on the ground are that the U.S. economy will continue to suffer as the Consumer Debt binge of the past few years comes to its inevitable conclusion. And the FED may not be able to EASE policy because if it does the USD is likely to TANK. That is: to fall at an even faster pace than it is currently falling. And should the USD really see panic selling then the U.S. financial markets are likely to get hit hard, bringing down STOCK markets world wide. What a charming scenario. The "cooling" of the U.S. economy continues and the FED may even be forced to HIKE regardless. Suddenly Bernanke discovers the EXTERNAL sector. What a Eureka moment.

So, even if the economy really falls into a black hole, monetary policy in the States will have to be played out with an eye on the foreign investor. And this is a reason to buy STOCKS? I think not. The Stock Market seems to disagree. For now. But it can’t last. The USD is still in trouble, the U.S. economy is still in trouble, the debt bubble in Consumer Land has burst and the ramifications will be felt for years to come. George W. is still in the White House and still intent on seizing permanent control of Iraqi OIL fields. Though he calls it: "bringing democracy". (I hope he doesn't decide to bring democracy to a place near me.) The cost of the endless War on Terror, or whatever they call it these days, will just keep going up. Bottom line: the funding requirement of the U.S. Government is not about to fall. George W. is not about to increase Taxes. The money has to come from somewhere. Somewhere for our purposes is defined as: the rest of the world.

In this context shoring up confidence in the USD becomes vital. So, while before the BERNANKE analysis pretty much had the U.S. economy in this nice safe bubble, conveniently separated from the unfriendly outside world, suddenly we have other considerations. Consideration N°1: the massive U.S. external funding requirement. The U.S. can’t afford to have foreigners desert Treasury Auctions unless it’s happy to see Yields on U.S. Treasuries rise to say, oh, something like 20-25%. Which is a possibility, but it wouldn’t do a whole lot for the domestic economy and it would probably be badly received in Voter Land.

Consideration N°2: a sharp, sustained fall in the USD would push up domestic inflation as the price of imports rise. But really this is small bananas. A couple of percentage points of extra inflation is not a big deal. What is a big deal is that MASSIVE external funding requirement. The real problem is how to keep the foreigners lining up with new money at every Treasury Auction. If it becomes clear the USD is likely to lose say 30% of its value in a repeat of the Nixon Years then the enthusiasm for more USD denominated paper might wane a little. Oh yes.

The U.S. desperately needs to maintain offshore confidence in the USD.

Given current leadership in the U.S.A. my money is on one result: FAILURE. This would be consistent with the other failures of the Bush Administration in Iraq and New Orleans. At some point, the U.S. will fail to convince enough fools to keep parting with even more money. It’s pretty much game over. All we have to worry about now is the timing.

The USD still remains the litmus test for what is going on and what is going on is ugly. More USD downside is inevitable. The only thing we are talking about here is speed.

OIL 62.49
GOLD 645.70

GOLD remains bid. While the PPT can do a lot to manipulate derivative markets it can’t do much about the solid physical bids out there coming from everyone from Saudi Arabia to China. Although there is no advertising going on the scramble to reduce exposure to the USD continues and GOLD remains one of the few plausible alternatives. There continue to be attempts to undermine the rise of GOLD (and the fall of the USD), recently someone even floated the idea that the IMF should sell a portion of its GOLD reserves because of financial constraints. Who knows this may even go ahead. Maybe the guy who came up with this idea is hoping to see a wave of copy cat selling by Central Banks. Here's hoping. Given the wall of money looking for a home, GOLD’s status as the International Reserve of choice is unlikely to be dented any time soon. If you see a dip: buy it.

The outlook for other, non-reserve commodities, is slightly more complicated. On the one hand an economic crisis will sap demand for commodities over time. In the short term, though, pressure on the USD is likely to see prices supported in USD terms. For now, a weak USD and ongoing trouble in the Middle East is supporting the price of OIL even as we have an economic crisis ready and raring to go. Longer term players should keep that in mind.

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