China Decides to Throw Some Cold Water on the Heating Economy

The dollar has rebounded very quickly the past few days, and there are no roadblocks right now. The risk takers in the markets are running for safety again, sent running by China’s decision to curb lending and attempt to slow growth before their economy overheats.

You see, China was the linchpin for risk taking, because with China growing, commodities were in need, and commodity countries were very happily sending those commodities to China. The commodity countries would then be flush with cash, rising job creation, and be confident about their future… Interest rates would rise to combat inflation in the commodity countries, and the karma would be flowing for each respective currency.

But China said, “Whoa there, partner!” And I don’t blame them… They seemed to be the only major country that was experiencing economic growth… I mean, China’s most recent quarter will probably show GDP at 10%! Hey! It takes two to tango! And in China’s case, it takes more than two to tango… So… They decided to throw some cold water on the heating economy, and see what they have when the smoke clears.

So… As we start today, the euro (EUR) has fallen to below the 1.42 handle, after spending most of yesterday gaining back lost ground to the dollar. The Aussie dollar (AUD), which was heading toward 94-cents just 10 days-or-so ago, has fallen below 92-cents, and so on… Shoot Rudy, even the darling of recent times, the Canadian dollar/loonie (CAD), has dropped back a bit… Risk taking is off the table.

The question is… For how long? In the past year, whenever risk aversion set in, it really didn’t last too long, and all it did was provide cheaper levels for investors to buy! So… The question du jour is how long the risk aversion will last before investors get tired of the paltry yields available in places like the US, and Japan… The two countries that seem to be favorites of the risk aversion campers.

Yesterday I told you about the rising prices in things that I got from Larry Edelson’s newsletter… Today, I’ll tell you about a few headlines that I came across last night on the Bloomie…

1. US Hog Prices ‘Rampage’ Higher, Pork Demand ‘Caught Fire’

2. Florida Freeze Kills Estimated 70% of Southwest Tomatoes, Other Vegetables

3. Sugar Rises in NY on Speculation Supply Deficit to Widen

So… the “deflationists” who don’t believe inflation is creeping all around us and ready to take our economy under, should pay attention here. Pork prices “rampage higher”… Florida freeze kills 70% of tomatoes… Sugar rises.

Soon we’ll not only have a dollar that’s robbing us of our purchasing power, but what dollars we have left will be getting eaten away by inflation… Where do I sign up for that?!

Also… I want to talk about something that I wrote yesterday regarding why the euro was seeing a slide down the slippery slope… I said it was the German Investor Confidence falling again… But after a reader asked me about it, and the more I thought about it, I knew that the Massachusetts election was playing with fire in the currency markets too. The currency traders were looking at the possibility of a Republican victory, which would not be a good thing for the health care bill, and therefore the dollar wouldn’t have to worry about an additional $1.5 trillion in deficit spending if the health care failed…

But as I told the boys and girls here on the desk… That still leaves $2 trillion in deficits for this year that have to be financed… And I’ll let you in on a little secret that’s just the Robinson’s affair… Last year’s Treasury buying was propped up by US financial firms that sold their toxic waste bonds to the Fed, and then took the funds and invested them in Treasuries… And the plan that came together to work all that out? It is supposed to end in March of this year. So… Without those financial firms buying the debt, who will be there to pick up the tab? I’m very serious here, folks… This is HUGE. Foreigners only bought about one third of our Treasuries last year.

Remember when I kept talking about the TIC’s data, and wondering why the dollar wasn’t getting punished? Because on the other side of the cocktail napkin, the Treasury was selling to financial firms, and the Fed, as I documented in the past… And all that comes to an end in March. Hmmm…

OK… I’ve been doing a lot of thinking about the Greece thing… and I know that I’ve ranted about how it shouldn’t be on the minds of investors over the problems in California, New York, Illinois, Michigan, etc. but… It is… and so I think we need to deal with this…

Now, you know my stance on the bailouts here in the US and that hasn’t changed, but it happened, and that’s now water under the bridge… The river may be swelling to take away that bridge, but it’s water under the bridge today…

Well… It now looks like Germany is going to have to step in and bail out Greece… Yes, I know that some European Central Bank (ECB) members have talked tough on Greece… I also don’t believe that they would jeopardize the European Union and the euro by ignoring Greece. So… I now feel as though Germany will have to step in. If they don’t, it could have a domino affect and cause some major harm to the euro. So, that’s something to watch for.

The major harm might be short-lived… Sort of like the slowest buffalo theory – where the slowest buffalo gets killed, but makes the herd faster. Greece would be the slowest buffalo, here… OR… It could send things spinning out of control in the Eurozone… So… In this case, we will have to go with Germany stepping in.

Last week, I carried on about the Fed making $52 billion last year, and wondered why this wasn’t as big a deal as Exxon/Mobil’s huge bonanza a couple of years ago. I mean, at least when Exxon/Mobil made billions, there were stockholders who benefited… Normal people – moms and pops, etc. When the Fed had the bonanza it handed it over to the Treasury, which some would think would go back to the taxpayers… Yeah, right…

But, I got to thinking this past weekend about the bonds the Fed is holding… No wonder they don’t want to see interest rates rise! For, if interest rates rise, their holdings would take on water, and… The Fed has stated that they intend to sell these bonds back to the markets some day… Well, try doing that when interest rates have risen on your bond holdings!

And… What happens if interest rates rise so high that the Fed starts taking on water, with negative interest rate spreads on the their holdings? Talk about cries to audit them then!

Gold had a mini-rally of $5 during yesterday’s trading, but overnight has sold off $9…

I want to make something perfectly clear, that I’ve talked about before regarding gold… When I talk about gold, I’m also talking about silver… I just don’t want to have to type gold and silver every time I’m talking about the precious metals. Silver is another store of wealth… In the December Currency Capitalist, I talked about giving the gift of gold, and teaching whomever you gift it to, the lessons of wealth building… When my older kids were youngsters, I bought them silver coins, for I could not afford anything else then. Those silver coins have proved the point of providing a store of wealth, as they have never gone to zero, and have gained in value over the years!

OH! And the Bank of Canada left rates unchanged and kept their statement pretty much the same at their meeting, yesterday. So… There was nothing there for the Canadian dollar/loonie…

And it looks as though I was barking up the wrong tree yesterday with my call that New Zealand’s inflation would be higher than expected, thus moving the Reserve Bank of New Zealand (RBNZ) to hike rates sooner than expected. New Zealand inflation actually fell in the fourth quarter 0.2%, putting the annual inflation rate smack dab on the RBNZ’s ceiling target of 2%. Now.. Having inflation at your ceiling target rate isn’t anything to ignore… But this is going to push back my call for higher interest rates by 75 BPS by summer… It will probably only be 25 BPS and maybe 50 BPS by summer.

Across the Tasman in Australia… Australian Consumer Confidence rose in January by the most in six months! Here’s another data piece that goes in the “pro” column for a rate hike in February by the Reserve Bank of Australia! (RBA) job creation is strong, as witnessed by last week’s jobs report, and now we have consumer confidence rising 5.6% last month! I would have to think that this pretty much nails it down for the RBA, and that they will hike rates at their February meeting – which would put Australian rates a full 3.5% ahead of US rates.

And finally, there was this… Our Foreign Bond Trader, Don Ries, came over to show me a bond issue that he found yesterday. Now… I must say that bonds are done in our brokerage, EverTrade Direct Brokerage, and are not FDIC insured deposits of EverBank… OK, now that I have that out of the way… OH! And this is NOT A SOLICITATION TO SELL THIS BOND! It’s simply information to make you aware of things… The bond was a 7-month bond, issued by a supra-national bank, the IADB (Inter-American Development Bank) that’s denominated in Brazilian real, that yields 7%!

The reason I’m telling you this, is simply to show you one of the reasons the Brazilian real (BRL) was posting a 35% return versus the dollar last year, and why the Brazilian government was doing whatever it could to slow down the real’s appreciation – which, by the way, they have done! When you have bonds denominated in your currency yielding more than 300 BPS higher than the rest of the world, you’re going to see a ton of interest in your currency to buy the bonds.

I’m still of the belief that the Brazilian government’s plans to stem the currency’s rise will run out of steam… It’s just a question of when…

Oh! And one more thing this morning… I don’t know if you track this or not, but the Hong Kong dollar (HKD) has been slipping in value versus the dollar recently. I find this to be a strange thing, in that the honker is supposed to be pegged to the dollar.

A couple of years ago, I made a call saying that China would allow the honker to float first, since it was the more mature currency, and see how that worked out, before doing so with their renminbi (CNY)… Could this be the beginning of that? Too soon to tell… But to see honkers losing value versus the dollar is strange… Strange indeed!

Well… The people of Massachusetts voted yesterday, and I think it says a lot when a state like Massachusetts doesn’t elect a Democrat… Maybe, just maybe, the government will get the message that voters don’t approve of deficit spending any longer!

About Chuck Butler 105 Articles

Affiliation: EverBank

Chuck Butler is President of EverBank® World Markets and the author of the popular Daily Pfennig newsletter.

With a career in investment services and currencies extending over 35 years, Mr. Butler oversees all aspects of customer service and the trading desk for EverBank World Markets. A respected analyst of the currency market, Mr. Butler has frequently made appearances or been quoted by the national media. These include the Wall Street Journal, US News, World Report, MarketWatch, USAToday, CNNfn, Bloomberg TV, CNBC, and the Chicago Tribune.

Mr. Butler was previously the Chief International Bond Trader and Director of Risk Management for Mark Twain Bank, and has held significant positions in the investment industry since 1973.

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