Quantitative Easing Has Sent the Dollar Into Free Fall

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The U.S. dollar has been in free fall since the beginning of September. The Federal Reserve acting in concert with the ECB (European Central Bank) is behind the action. Most other countries are seeing rising currencies and this is going to hurt their economies and the American economy as well.

It's become a running joke globally that the U.S. follows a strong dollar policy because the evidence so blatantly contradicts this claim. Things have gotten even worse lately with the dollar-trashing activities of the Fed going into hyper drive in time for the November election.  The trade-weighted dollar (DXY) lost approximately 6% of its value in September alone. It is not coincidental that the Dow Jones Industrials went up more than 10% during the month or that gold hit one all-time high after another. Stock markets rise when a currency is being devalued. All commodities are priced in U.S. dollars, so all else being equal; a commodity's price has to go up when the dollar falls. Rising commodity prices under such circumstances do not indicate a robust economy, they indicate inflation.

A cheap currency is indeed a plus for a major exporter. Currently China is the prime example globally of a economy that benefits a great deal from a currency with a low value. The Chinese yuan (CYB) doesn't really float, it can only have a small change in value during any given time period, so it can remain underpriced. The EU has now joined the U.S. in demanding China let the yuan have a more realistic value. China denies it is manipulating its currency however. If this is the case, it should just let it float freely on world currency markets and the value would remain approximately the same. For some reason, China is reluctant to do this.

Unlike exporters, major importers like the U.S. do not benefit from declining currencies. For more than four decades, the U.S. has followed policies that have destroyed its industrial base. The private commercial sector is now 20% manufacturing and 80% services. A weaker dollar will give more business to the manufacturing 20%, while hurting the service sector's 80% with more inflation. It won't solve the U.S. unemployment problem. At the same time it will damage the economies of exporters by raising their costs for commodities and the prices of their goods. All in all, it's a lose/lose situation.

The Federal Reserve's new quantitative easing program, first announced in August, is what is undermining the dollar and wreaking havoc in global currency markets. The euro (FXE) has recovered to the 1.40 area, but this is also due to the almost $1 trillion Euro-TARP bailout of the EU currency. The Japanese yen keeps rising and hit another multi-year high today. The Japanese monetary authorities have intervened in the currency markets to stop the yen from climbing, but to no avail. The Swiss franc (FXF) broke above parity with the dollar in August. The Australian dollar (FXA) is about to follow the Swiss franc's lead. The Brazilian currency (BZF), one of the weakest on earth for much of the twentieth century, is beating the stuffing out of the U.S. dollar.    

The big drop in the dollar is not likely to continue much longer (although the charts indicate there could be another leg down). It is already causing destabilization in world markets and could lead to another global financial crisis if it does. If Fed Chair Bernanke continues with his enthusiasm for quantitative easing though, the dollar could hit an air pocket and wind up much lower overnight. While the Fed's interest in quantitative easing will probably cool suddenly after the election, it may continue to play its dangerous game of chicken with the dollar until then.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Why China is About to Change Its Currency Policy

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Reports are out today, April 8th, that China is about to abandon its fixed rate currency policy instituted in July 2008. It is likely to let the renminbi revalue upward a small amount immediately and then trade in a narrow trading band on any give day after that. China took such an approach in 2005. The U.S. has been pressuring China for this change.

The Obama administration had a report that was supposed to be delivered to congress on April 15th on whether or not China was a currency manipulator. This has become an increasingly sore point in U.S. China relations. It was abruptly announced a few days ago that the report would be delayed. Treasury Secretary Geithner has since gone to China and met with officials to get them to be more flexible with the renimbi's exchange rate. The Chinese have remained adamant that their currency isn't undervalued. If that was indeed the case, they should simply let it float freely and everyone would be happy. There is of course zero chance that that is going to happen at this point in time.

Keeping the value of a currency artificially low is a boon for a country's exporters because it makes their goods cheaper. Business and labor interests in the country with the artificially high currency necessarily lose out. This is a good description of Japanese U.S. trade situation in the 1970s and early 1980s. Now China has a huge trade surplus with the United States and has accumulated approximately a trillion dollars in reserves of U.S. currency.  The U.S. gains from China's undervalued currency policy because China recycles the hoard of dollars its gets from its trade surplus by buying U.S. treasuries (Japan did the same thing). This allows the U.S. in turn to run massive budget deficits because it can borrow a lot of money from China. That game may be up however. China was a net seller of treasuries for three months in a row up to this January (the latest month for which figures are available).

Keeping a currency undervalued is not without its risks. One of those major risks is inflation. China has compounded that risk even further by engaging in a massive stimulus program while its currency was frozen. Inflation does seem to be bubbling up internally within the country and even beyond its borders in higher prices for commodities. Chinese buying is the key driver of commodity prices.  China is in fact the epicenter for potential global inflation and this will impact the U.S. despite any moves the Federal Reserve takes to try to dampen rising prices.

In the long-term, China will have to let the renminbi peg to the U.S. dollar, China will still need to maintain stringent capital controls to prevent big moves in its currency if the renminbi is inappropriately valued (many experts claims it would rise 40% if it floated freely).  Economic forces always win in the end and the Chinese leadership will eventually find this out.

ETNs that can be used to take a position in the renminbi are CYB and CNY.

Disclosure: None

NEXT: Currencies React to Ongoing Greek Debt Crisis

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A China in a Bull's Shop

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


After its own stock markets closed on January 12th, the PBOC (People's Bank of China) ordered a boost in the yuan reserve requirement ratio for banks by half a percentage point. U.S. stocks immediately sold off on the news, gold dropped $15 in only minutes, and the U.S. dollar also declined. The market viewed this as the beginning of a tightening cycle on the part of the Chinese. While analysts are debating this, it is almost certainly true. Claims that China beginning to tighten monetary policy now will be able to head off future inflation however are grossly overstated and can be put in the category of wishful thinking.

When it comes to bank lending, China has the opposite problem of the United States. Banks in the U.S. have yet to start lending again despite half a dozen support and giveaway programs from the Federal Reserve and Treasury Department that are meant to encourage them to do so. Bank lending in China is surging out of control though. Lending in the first week of 2010 was greater than the entire month of November 2009, which in turn was already strong. Analysts claim that PBOC's move will remove 200 to 300 billion yuan from the banking system. Bank lending in the first week of this year was 600 billion yuan, so the drop in liquidity caused by the new rules represents taking away half a week of lending. That should be about as effective as trying to take down an elephant with a fly swatter.

Only a significant change in monetary policy is going to have any impact on future economic numbers. Central bank interest rates are either zero or close to zero in most major economies. Raising that number half a point, a point, even two points still indicates an easy money policy. Even that is not going to happen in the foreseeable future. China itself uses interest rate hikes to cool down its economy and last did so in 2007. It has yet to start a new tightening cycle. Starting that cycle won't be enough to stop inflation either. Inflation is an insidious phenomenon that takes years to work its way through an economy. There is as much as a four-year lag between a period of easy money and a first peak in the inflation rate. That takes us at least to 2012. In the 1970s U.S., money supply expansion peaked in 1971 and inflation peaked nine years later in 1980. Trying to control inflation after money expansion has occurred doesn't work, unless severe measures are used.

Governments also fail to control inflation because they fail to focus on the cause. In China's cases, they froze their currency at the beginning of the Credit Crisis, so it is extremely undervalued. Keeping a currency at too low an exchange rate is highly inflationary. When inflation shows up in China in the not too distant future, the key to stopping it will be to significantly value the yuan upward. Other measures will prove to be ineffective, but like most government throughout history, China is likely to take the easy way out and avoid taking the necessary steps needed to reduce inflation.

As an interesting aside to China's bank announcement, it should be noted that the yen is selling off against the U.S. dollar. Almost every other currency is rallying against the dollar and some very strongly. It is quite clear that this was part of some central bank maneuver to drive down the yen. The large drop in the price of gold, which took place in minutes on the 12th, also required a large amount of capital backing it. Central banks have that large amount of capital. This ordinarily would have rallied the U.S. dollar strongly, but didn't. Manipulating the gold market is one of the old reliable techniques governments use to support the U.S. currency. Central bank actions rarely impact the markets for too long if there is no fundamental support backing up their moves. When the U.S. stops borrowing and printing money and raises interest rates substantially, real support for the dollar will exist. Until that happens, the long-term downtrend will continually reassert itself.

Disclosure: Long gold.

NEXT: 2009 Retail Sales Deconstructed

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

America's Other Deficit - More Borrowing Ahead

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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Everyone knows about the huge U.S. budget deficit and ever climbing national debt (now approaching $12 trillion), but much less attention is paid to the Trade Deficit. Both have multi-decade histories at this point. With the exception of the last four years of the Clinton administration, the U.S. has run budget deficits since 1970. There have been continual trade deficits since 1977. While the U.S. budget deficit hit a record high of $455 billion in fiscal year 2008, the Trade Deficit also hit a record by the end of the year and was even larger at $695.9 billion. Both deficits have to be paid for by borrowing, although the trade deficit has be funded by borrowing from foreign sources. This is how the budget deficit has been funded for many years as well, until the U.S. had to start resorting to out and out money printing in 2008. Few people realize though that the Trade Deficit can actually be a bigger drain on U.S. credit than the budget deficit is.

The reason for the current complacency is that the budget deficit soared in fiscal 2009, while the trade deficit is shrinking this year because of the after effects of the Credit Crisis on global trade. The U.S. trade deficit is now projected to come in at annual $366 billion for 2009. The budget deficit for fiscal 2009 (ending on September 30th) was $1.4 trillion. Next year's budget deficit is projected to be over $1 trillion as well. Whether the U.S. trade deficit has bottomed is dependent on the level of global trade and the price of oil. Oil is the key swing factor and if oil prices rise significantly they will overwhelm any benefits in rising exports from a falling U.S. dollar.

U.S. trade deficit figures for September was released on November 13th. The monthly deficit was $36.5 billion, almost $5 billion greater than analysts had expected. One media headline summed up the situation perfectly (a rare event for the mainstream financial press), "Trade deficit jumps more than expected in September as big rise in foreign oil swamps export gain". Rising prices led to oil imports going up 20.1% and imports overall 5.8% higher. Exports did indeed rise on the falling dollar, but were up only 2.9%. They were overwhelmed by the bigger import number thanks to oil.

While economic recovery means a potentially better U.S. budget deficit, it also means a worse U.S. trade deficit. Recovery outside the U.S., but a weak U.S. economy would be the worse of all worlds. Commodities are priced based on global demand and roaring economies in East Asia can drive the price of oil higher and higher. The U.S. trade deficit would rise and so would the budget deficit creating a self-feeding inflationary spiral. The Chinese economy is already much stronger the U.S. economy and yet the September U.S. trade deficit with China was $22.1 billion. China has managed to keep its exports high because it re-pegged its currency to the U.S. dollar in mid-2008 and this keeps the price of Chinese goods low in the West. It is generally believed the Chinese yuan is 40% undervalued because of the government doesn't let it float. While this undervaluation has allowed China to continue its high level of exports, there will be a price to pay down the road. Undervaluing currencies, just like excessively low interest rates and money printing, is inflationary. The market made this point clearly when the trade deficit news was released, gold shot up and the U.S. dollar sold off.

Disclosure: Long gold, no positions in the U.S. dollar

NEXT: Future U.S. Bailouts - FHA, FDIC, PBGC and U.S. States

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Market Rally at Key Juncture; Russians at it Again

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The market rally is getting tired in here. Whether or not it can have one last gasp at this point will probably be decided today. The technical picture on the S&P 500 will turn decidedly negative if there is any significant sell off today. Conversely, a significant rally can turn it positive. Close to unchanged and we have to wait until tomorrow. I haven't been waiting to sell however and started doing so toward the end of last week. Most of my positions in DXO, ERX, and HWD are gone. My major energy position in now in UNG, which I plan on continuing to accumulate on major drops (this may no longer be at prices under 14, which may be a thing of the past for the moment). For those not paying attention, I sold AA long ago. I did pick up some NG and GDX yesterday however.

Like the market, oil is having trouble rallying at this point. Light sweet crude closed at 70.62, but was back above 72 again this morning. The weekly storage report comes out tomorrow and this will determine whether oil can make a run to 77 or have to fall back well into the 60s first. I will be a buyer again if it reaches the lower 60s.

The trade-weighted dollar was falling again today, but has managed to stay above 80. It once again moved on comments coming out of Russia. Last week they were selling their U.S. dollar holdings , the dollar sold off sharply. This weekend, they weren't selling their U.S. dollar holdings, the dollar had a big rally. Today, they are doing both. At a Russian/Chinese summit, the Russian president stated, "We must strengthen the international financial system not only by making the dollar strong, but also by creating other reserve currencies". Creating other reserve currencies would of course weaken the dollar considerably. Russia also wants to diversify its currency reserves by buying Chinese yuan, Brazilian reals and Indian rupees. Now I wonder what currency it would be selling so it could buy them?

Gold and silver had sell offs because of the dollar rally yesterday. Since this rally was based on fantasy, I am not currently taking it too seriously. How long the dollar can stay above its 78.33 breakdown point is anybody's guess, but it will get there evntually. The central banks that are major dollar holders are all probably trying to dump their dollars as discretely as possible at the moment. Don't expect them to advertise this on a big neon sign, even though Russia essentially did this last week. The reserve currency status of the dollar will also definitely be coming to an end sometime in the next several years as well. Few things are more certain.

NEXT: Best to Step Aside and Watch the Market

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Synchronized Contractions Give Birth to Global Recession

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Recently released manufacturing numbers in the U.S., Europe, and Asia are off the charts. Unfortunately the part of the charts they are off is the downside. While the media was trumpeting the biggest global expansion ever last year, the New York Investing meetup pointed out that every economic expansion in history has been followed by a contraction and therefore the biggest expansion ever was likely to be followed by the biggest contraction. The most recent figures for manufacturing activity show that this is exactly what is taking place.

In the U.S., the ISM fell to 36.2 (anything under 50 indicates contraction), the lowest since the recession of 1982. The Prices Paid component fell to 25.5, the lowest since 1949. Falling commodity prices were blamed for the sharp drop. The Order Backlog component was the lowest ever. Manufacturing in Europe isn't in any better shape. In Britain, the Chartered Institute of Purchasing and Supply index fell to 34.4. The VTB Bank Europe Index for the Eurozone including Russia fell to 39.8. In Asia, two purchasing manager surveys in China fell to 38.8 and 40.9 respectively. The Yuan fell limit down on the news. As further corroboration of a global contraction, the most recently released semiconductor sale figures indicated a drop of 2.4% in sales year over year.

The markets didn't react kindly to this plethora of bad economic reports. As of this writing, NYMEX oil has dropped as low as $50.76. The markets in Europe had crash level drops on the day, with the exception of the FTSE in Britain, which missed the cut off by a hair. In the U.S., the Nasdaq and S&P 50 are trading at crash levels so far. This is taking place after the biggest up week for the U.S. indices since the mega-bear market in 1974. Last week the S&P 500 rose 12%, the Nasdaq 11%, and the Dow 9%. Too much, too fast is never sustainable in stock market action and today's trading is showing that once again the validity of this rule.

Retail reports for Black Friday aren't much to cheer about either. While sales supposedly went up 7.2% from last year, surveys indicate that 70% of shoppers purchased only deeply discounted items. So sales might hold up, but retail profits are likely to plummet. The desperation for bargains was so acute that a Walmart worker on Long Island was trampled to death. In bad economic times, the public's actions can indeed become quite ugly.

NEXT: NBER Admits that New York Investing Was Right

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

China's Olympic Sized Bubble

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The credit bubble in the U.S. did not exist in isolation, but was inextricably linked to a bubble in China U.S. trade. One of the many manifestations of this bubble was a Chinese stock market that started going straight up in late 2006, reaching extreme valuation levels based on any historical standard. The New York Investing meetup discussed this issue in its October 2007 meeting in a presentation entitled, "Thinking Outside the Bucks" (please see: http://investing.meetup.com/21/files).

In the 1990s and early 2000s, China was the most significant economic success story in the world. Rapid industrialization and trade grew the Chinese economy and kept consumer prices down in the West. This was accomplished by utilizing China's large pool of inexpensive labor to produce an increasingly greater number of goods for export. Since labor is the largest cost component for almost all manufactured goods, this lowered prices globally for a number of items. However, China went one step further to insure it could continue to sell its exports at low prices - it pegged its currency to the U.S. dollar (an idea originally suggested by the American monetary authorities, much to the later regret of U.S. politicians). The dollar peg allowed China to keep its currency undervalued, just as Japan had done during its decades of spectacular growth, and provided its exports with a huge advantage in world markets. It also insured the creation of a massive bubble.

As Chinese exports to the U.S. increased, China accumulated a growing hoard of dollars that it used to purchase U.S. treasury bonds. This in turn kept interest rates low in the U.S. and allowed Americans to borrow ever greater sums to finance a purchasing-based consumer economy and for the U.S. government to borrow cheaply to finance a ballooning national debt.
Pegged currencies are not without their downsides, however, as China eventually found out when its internal rate of inflation began rising. In July of 2005, China officially, but not actually depegged the Yuan from the U.S. dollar. The Yuan was allowed to float in such a narrow trading band that by September 2007 it had fallen only to 7.50 from 8.28 to the dollar. Since the Yuan wasn't allowed to float to a realistic level, inflation started taking off in the mainland and the Chinese government announced price controls that month to try to halt it.

Meanwhile, the greater wealth created within the Chinese economy led to an exploding stock market. This bubble in stocks was further fueled by asset controls that prevented most Chinese investors from moving their money outside of China. The effects of this could be seen by examining prices of Chinese stocks that traded in both the mainland and Hong Kong. The prices on the mainland exchanges were much higher than those in Hong Kong. In August of 2007, the Chinese government announced a policy shift that would allow mainland investors to buy and sell stocks in Hong Kong. The effect of stock prices in Hong Kong was explosive and only days later the Chinese government announced this policy change would be on hold for the foreseeable future.

For more on this topic, please see the video: "Global Perspectives on the Decline and Fall of the U.S. Dollar" at: http://www.youtube.com/watch?v=dbHxbOvjYis&NR=1

Next: All that Glitters Isn't Gold, It's Also Silver

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please go to our web site at: http://investing.meetup.com/21.