Wednesday, August 01, 2007

The End of Pretend Money

EUR/USD 1.3654 Hi 1.3684 Low 1.3641
USD/JPY 117.83 Hi 118.73 Low 117.58
AUD/USD 0.8471 Hi 0.8542 Low 0.8444
EUR/JPY 160.87 Hi 162.23 Low 160.51

There was a hilarious line of thought going around the market recently which centred on the naive belief that if the Japanese decided NOT to raise rates in August then the Yen Carry Trade could be saved. In short the Happy Clappy crowd seemed to believe that Humpty Dumpty could be put back together and everything could go back to how it was. And how it WAS was pretty good with virtually free money from the Yen Carry Trade providing the 'liquidity' (read pretend money) for every speculative trade on the planet. The upshot being that speculative traders everywhere would, after this little 'correction', be able to get back to their rewarding momentum trades and we would all live happily ever after.

For good measure some deluded newspapers were spouting the view that Japanese housewives would help this along because of course Mrs. Watanabe and her friends had just come into a whole lot of new cash, or something. No-one was too keen to explore that line of thought in all its gory detail because it wouldn't stand up to much examination. But they threw it in just for good measure.

Meanwhile back in the real world what the Asians were actually discussing was what they could do with their trade earnings, of which there is rather a lot, if they decided not to keep lending the money to the Americans. The Asian Development Bank had got in on this. In Japan there were noises about how the large stash of cash currently sitting in U.S. Treasuries could be used to pay off the correspondingly large Japanese Government Debt. The Chinese were 'diversifying'. Nowhere in Asia was anyone talking about pouring even more money into what was essentially seen as a losing proposition. That is: exchanging real goods for ever larger quantities of small bits of green paper (aka the USD) which could only be exchanged for slightly larger bits of paper (aka U.S. Treasuries) which essentially meant exchanging real stuff for nothing much and certainly for nothing useful.

The Happy Clappy crowd missed that bit. But then they don't read the foreign press and they enjoy a self-delusional lifestyle generally. So while the Western Press fed anyone who would listen the line that Asia had no choice but to continue financing the U.S. economy and the U.S. Government the Asians were looking at their alternatives. And this shopping around for choices has been going on for a while now. This does not bode well for the USD/JPY and the Carry Trade and, of course, this is bad news indeed for people in Hedge Fund Land because funny money generated by the Carry Trade was how the people in Hedge Fund Land amplified their trades to the power of a billion. And this has unfortunate consequences when winning trades turn into losing trades. Like now.

But there is more. The Happy Clappy crowd was also led to believe that the melt down in the U.S. Housing Market could somehow be contained. It's only Sub-Prime, it's only a small share of the market, it doesn't matter and anyway who cares Ben Bernanke will come to the rescue. We hope. Only Helicopter Ben has discovered that he has exactly no lee-way when it comes to domestic interest rates because the real money is coming from overseas and overseas investors want to see the FED prop up the USD and to hell with the U.S. economy. That's a policy conundrum which seems to have finally registered with the FED, hence all the talk of inflation risk, which is really the USD collapse risk.

Where does it all lead? Well first off the USD/JPY downtrend has only just begun. When you think USD/JPY think down because that's where it's going.

And if the USD/JPY up trend is over and the Carry Trade is over, which they are, then this means that all this exciting 'liquidity' disappears and what we have is a credit crunch, which won't be good, particularly for economies which are debt dependent. The countries which will fare the worst as liquidity dries up are those countries which have seen a credit explosion in the past decade. Countries with low or no domestic savings, high domestic debt levels and no contingency plans are in for a very difficult time indeed. Think debt, think Anglo-Saxon economies, think crunch.

For a while it worked. Asians were encouraged to work very hard, produce goods to sell to the rich Westerners, bank the money and never spend it. In fact, they lent the money back to the Westerners in order to keep the whole process alive. But now questions are being asked and the issue is unlikely to be resolved in favour of those countries which are used to receiving large, never-ending capital inflows (aka as other people's money).

It was after all an American who said: 'You can fool some of the people all of the time and all of the people some of the time but you can't fool all of the people all of the time'.

And the Euro? Well the new French President, Mr. Nicholas Sarkozy, has been making loud noises about ECB monetary policy and the EURO uptrend, which he doesn't like. Not surprising really given the impact on the European economy. So the EUR/USD uptrend may have stalled but the EUR/JPY downtrend has just started and the real action will be in the big Carry Trade favourites: AUD/JPY, NZD/JPY and USD/JPY.

While the rush for the exits takes place U.S. Treasuries and Government Bond Markets are expected to outperform. Because the USD remains at risk, however, the U.S. Treasury market is expected to underperform other Government Bond Markets. By quite a bit.

OIL 78.00
GOLD 673.40

The focus for now is not on GOLD or OIL. Both are reasonably bid but action on other markets is likely to take the heat out of these. In the longer term GOLD is likely to outperform while OIL takes a hit as global economic conditions worsen. And incidentally the outlook for Stocks just keeps getting worse.

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