Search results matching tag 'The Fed'

Where the Wild Things Are

JohnMauldin — Sat, 21 Nov 2009 05:49:00 GMT

Where the Wild Things Are
It Is Not Just Japan
The Euro-Yen Cross and the Dollar Carry Trade
New York, London, and Switzerland

From ghoulies and ghosties
And long-leggedy beasties
And things that go bump in the night,
Good Lord, deliver us!

--Old Scottish Prayer

Where the Wild Things Are is a beloved children's book and now a beautiful movie. But in the investment world there are really scary wild things lurking about in the hidden recesses of the economic landscape. Today we look at one of the unintended consequences of the Federal Reserve's low interest rate policy.

For quite some time, I have been arguing that we are faced with no good choices, not just in the US but in the entire "developed" world. I see a low-growth, Muddle Through world over the next years (with a double-dip recession just to liven things up). However, that does not mean that we will lack for volatility. Things could get volatile rather quickly. Let's quickly set the background.

It Is Not Just Japan

Let's look at today's interest rate picture. Yesterday, we had the bizarre occurrence of banks actually paying the government to hold their cash. Three-month treasuries yield a miniscule 0.01% in interest. If you opt to buy a one-year bill you get all of 0.26%. You can see the entire spectrum below.

Look at the graph of the yield curve below. It is as steep as we have seen it in a long time. But that is almost the point. Banks are essentially getting free money. If you are a banker and can't make money in this environment, you need to quit and find meaningful employment.

And that is part of the rationale that the Fed espouses with its low interest rate regime. Not only does it allow banks to repair their balance sheets, it also encourages investors to put money into riskier assets in order to get some return on their investments. Over $260 billion has gone into bond funds this year, and just $2.6 billion into stock funds. However, you have to balance that with the fact that some $400 billion has left money market funds paying less than 0.2%. So there is some movement to capture yield.

But is it just banks that are getting cheap money? And is encouraging investors to find riskier assets a sound policy? Maybe not.

The Euro-Yen Cross and the Dollar Carry Trade

I wrote a great deal in the past few years about the strong correlation of the euro-yen cross to stock markets all over the world in general. (The euro-yen cross is the exchange rate of the euro and the Japanese yen.) This was a proxy for the Japanese carry trade. The stock markets of the world rose and fell in synchronization with the yen versus the euro.

A currency carry trade is a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage used.

The Japanese drove their rates down to essentially zero in the 1990s. By early 2007, it was estimated that the yen carry trade was over $1 trillion. But when the world credit crisis hit, the world wanted dollars. They paid back the yen and bought dollars, driving the yen higher and killing the yen carry trade. Who wants to borrow in a currency that continues to rise, even if the costs are low? And often, large leverage was used, so small movements in the currency could destroy outsized amounts of capital.

But now, there are some who are beginning to ask whether there is a dollar carry trade. In the last nine months, the correlation between the dollar and the stock market has gone to about 90%. If the dollar rises, the stock markets and other risk assets tend to fall, and vice-versa. It would appear that investors and funds are borrowing cheap dollars on a short-term basis and investing in all sorts of risk assets. Not only have stock markets risen, but so have high-yield bonds, commodities, and so on.

We have seen the steepest rise in US stock markets coming out of a recession since the end of the last world war. The market is "discounting" a 5% GDP next year and a profit rebound beyond anything in past experience. Depending on the quarter, operating earnings are expected to rise by anywhere from 30-40%. P/E ratios are back at 23, well above the 17 we saw in the summer of 2007 (I am using 4^th quarter 2009 estimates so as to not have to take into account the disastrous 4^th quarter of last year.)

Worrying about a dollar carry trade is not just a preoccupation of my friends Nouriel Roubini or David Rosenberg or Frank Veneroso. Look as this story from Bloomberg:

"China's Liu Says U.S. Rates Cause Dollar Speculation

"Nov. 15 (Bloomberg) -- The decline of the dollar and decisions in the U.S. not to raise interest rates have caused "huge" speculation in foreign exchange trading and seriously affected global asset prices, said Liu Mingkang, chairman of the China Banking Regulatory Commission."

"The continuous depreciation in the dollar, and the U.S. government's indication, that in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," he told reporters in Beijing today at the International Finance Forum.

"Liu said this has 'seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.'

"His view echoes that of Donald Tsang, the chief executive of Hong Kong, who said the Federal Reserve's policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis."

"'I'm scared and leaders should look out,' Tsang said in Singapore Nov. 13. 'America is doing exactly what Japan did last time,' he said, adding that Japan's zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown."

It is not just China. Brazil has moved to impose a tax (or tariff) on investment money coming into the country on a shorter-term basis, as they are worried about both a bubble in their markets and in their currency. Russia is openly considering similar policies.

I have been doing a lot of speaking in the last month. In almost every speech, I warn of the significant imbalance in the dollar. I walk to the very end of the stage to help illustrate that the world now has on a massive ABD trade. By that I mean Anything But Dollars. Everyone is now on the same side of the boat. They have borrowed dollars to buy other risk assets, assuming that the dollar, like the yen in the glory days of the yen carry trade, will continue to fall. Dollar bears are everywhere.

Explanations abound for why the dollar is a trash currency. It is Fed policy, or the Obama administration's willingness to run massive deficits, or the trade deficit or our health-care policy or (pick any number of issues). But I wonder.

Global trade collapsed last year and well into this year. Global trade was essentially done in dollars. If global trade is down 20% or more, then there is less need for companies in various countries to hold dollars and more need for local currency because of the crisis. Thus, after a rush to safety in the credit crisis, there is a rational selling of dollars by business.

Look at the above chart. Notice that the dollar is roughly where it was 20 years ago. And notice the recent jump during the credit crisis. We are not even back to where we were before the crisis.

What happens if world trade picks back up, as it appears to be doing? Admittedly, it is not a robust recovery as yet, but it is rising. That means more need for dollars. And dollars which are being borrowed (and probably leveraged!) on the assumption the dollar will continue to fall.

And I agree that, over time, the case for the dollar is not as good as I would like. But in the meantime, we could have one very vicious dollar rally, which would take equity markets down worldwide, along with other risk assets. Why? Because it would be a major short squeeze.

Barron's just did a survey. It revealed that the bullish sentiment on stocks is quite high and almost everyone hates US treasuries (graph courtesy of David Rosenberg of Gluskin, Sheff)

Whenever sentiment gets too strong in one way or the other, it is usually setting up the markets for a rally in the despised asset. Mr. Market like to do whatever he can to cause the most pain to the largest number of people.

I am not predicting a near-term crash or imminent precipitous bear, although in this environment anything can happen. I am merely noting that there is an imbalance in the system. The longer this imbalance goes on, the more likely it is that it will end in tears. And the irony is that a recovering world economy could be the catalyst.

The Wild Things? They may be hiding in a portfolio near you. Just food for thought. Stay nimble.

New York, London, and Switzerland

I am going to hit the send button on what may be the shortest e-letter I have ever done. The travel is catching up with me and I need some rest.

I am looking forward to Thanksgiving next week. It may be my favorite holiday. Family, friends, food, and football. My usual pattern is to get up very early Thursday and start the prime slow-cooking, and then turn to the side dishes. It will be no different this year. My brother will bring the smoked turkeys, which he has down to an art form. And then there are the over-the-top wines I was so graciously given this past birthday by so many friends. I will bring a few of those bottles out.

The next weekend I am in New York for Festivus with the crowd from Minyanville, and then I am home for over a month before I go to London and Switzerland in late January. Then not much is currently scheduled until April, although it always does seem to change. After the recent hectic schedule (15 cities and even more speeches in just a little over three weeks), I look forward to some home time.

I wish those of you in the US the best of Thanksgivings, and the rest of you a great week. And thanks for all the very kind words of late about Tiffani. She seems to be doing better. She is due in a month, so she is still moving slowly, but you can sense the excitement in her and Ryan. I find it all very pleasant.

Your "there's no place like home" analyst,

John Mauldin

Carry Trade reversals rally dollar / yen

ChuckButler — Thu, 19 Nov 2009 15:13:25 GMT

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In This Issue..

* Carry trade reversal boosts the dollar/yen...
* STL Fed Head Bullard sends mixed signals...
* Audit of Fed in jeopardy...
* Kiwi and AUD fall...

And Now... Today's Pfennig!

Carry Trade reversals rally dollar / yen

Good day... And a Thunderin Thursday to you! Yes, the rain continues today, but I hear it is supposed to stop this afternoon. Fear of risk rained on the currency investors' parade as an equity market sell-off fueled a US dollar and Japanese yen rally. At times it looks as if we will break this pattern of markets up dollar down/ markets down dollar up, but it seems investors continue to return to the US$ and Japanese yen as soon as they become worried about equity market returns.

Many of the callers into the trade desk wonder how anyone would be buying the Japanese yen and US Dollar as 'safe haven' currencies. I think a lot of this buying of yen and dollars isn't necessarily due to investors believing they are safer in US$ and Japanese yen, but is a result of the reversal of carry trades. The dollar and yen are the two major funding currencies of the carry trade. Investors borrow yen and dollars and then invest the proceeds into higher yielding assets including equities. This is what is called the carry trade, and works best when an investor can use high leverage to increase the return. Since these trades are highly leveraged, they are closely monitored and reversed at the first sign of a possible fall in the value of the higher yielding assets. So while the popular press will talk about the 'perceived safety' of the yen and US$, I believe much of the dollar and yen buying is due instead to a reversal of the carry trade. Investors aren't buying these currencies because they think the Japanese and US economy are stronger and therefore safer than others, but are simply deleveraging to take risk off the table, and are buying yen and US$ in the course of this deleveraging.

So what caused investors to worry about their investments in the equity markets? Chuck sent me this note before heading out the door last night:

I saw currencies jump around again on Wednesday... But here's something that makes me scratch my bald head, and should make you wonder too... If you're confused with this, then don't feel alone... Fed Head Bullard was speaking yesterday and at one point he said... "FED MAY NOT START TO RAISE RATES UNTIL EARLY 2012" That really got the currencies going... But later in the same speech, he said, "MEMORY OF HOUSING BUBBLE MAY PUSH FED TO START RATE HIKES MORE QUICKLY THAN AFTER PAST RECESSIONS." WHAT? He said that the Fed may not start raising rates until 2012, but then says that the Fed may push to start rate hikes more quickly than before? In my best Andy Rooney voice... Do you ever wonder, how these Fed Heads get in the door? Oh well... The second statement didn't change the currencies, but it did change stocks... And for one of the first times in some time... U.S. stocks sold off, and non-dollar currencies rallied.

As Chuck points out, the St. Louis Fed Head Bullard seemed to be speaking out of both sides of his mouth, but his second statement that the Fed may push to start rate hikes more quickly than before scared equity investors. He stated that in the debate to tighten policy, "the idea that you might be creating asset bubbles by keeping rates too low for too long will be an important argument." This is what scared the markets.

The economic data released yesterday certainly didn't help investors confidence in the global recovery as US housing starts unexpectedly dropped 11% in October compared to the month before. The pace of construction was the fewest since April's record low, and illustrates housings reliance on government support. Obama has extended both the first time homebuyer's tax credit and instituted a new (and I believe stupid) program to give existing homebuyers a tax credit to go out and buy a new one. These programs will probably give a bit of life support to the housing market in November, but many question just how long the government can continue them.

Another piece of data released showed the cost of living in the US rose more than forecast in October as the price of gas pushed CPI up .3% following a .2% rise in September. Today we will get the weekly jobs data along with the Leading Indicators for the month of October. Last month's leading indicators surprised the market with a 1% increase, but this month the expected rise is just .4%. This would be the seventh consecutive month of increased indicators begging the question: Just how LEADING are these indicators??? They have posted positive gains for seven months, but the economy sure doesn't feel like it is picking up steam. Housing and unemployment continue to be drags on the US economy and, according to Chairman Ben S. Bernanke, economic 'headwinds' will limit the recovery for an 'extended period'.

Speaking of our esteemed fed head, Bernanke's clout among US lawmakers will be tested today as the House Financial Services committee will consider how much to expand audits of the US central bank today. Panel members will be voting on a Democratic proposal to retain a ban on audits of the Fed interest-rate decisions. This would be a big blow to Ron Paul and his bill to allow audits of the Fed. Unfortunately I believe the Democratic ban on audits will pass, and Ron Paul will have to figure another way to try and hold the Fed accountable.

The worst performing of the currencies vs. the US$ over the past 24 hours is the New Zealand dollar which fell by over 2%. The kiwi dropped as the nation's main opposition party said it will no longer accept the central bank's primary policy of targeting inflation. The head of the central bank's salary is actually tied to keeping inflation rates at an acceptable level. This is one of the main reasons interest rates in New Zealand have been among the highest of industrialized nations. But in the opinion of the nation's main opposition party, these high rates have been at the cost of slower growth and a weaker exports. In my opinion, having a central bank focus on keeping inflation within a targeted range is absolutely required; and tying the main policy makers income directly to this objective is smart.

The Australian dollar also dropped for a second day on interest rate speculation. As Chuck has written, the markets have expected the Reserve Bank to raise rates again at their December meeting, but minutes of their Nov. 3 meeting caused some concern that they will not raise rates again until 2010. The minutes, released yesterday, said the pace of interest rate increases is an 'open question' as policy makers balance the risk of inflation vs. an economy which could slow as government stimulus ends. But I am still firmly in Chuck's camp, and believe the RBA will raise rates in December, and the interest rate differentials will continue to rally the AUD$ vs. the US$.

Minutes of the Bank of England's November meeting were also released yesterday, and showed the policy makers were split on whether to extend the 'quantitative easing' program or possibly cutting rates further. The pound sterling lost ground against both the euro and US$ as investors worried about the lack of direction. The minutes show there are three different camps at the BOE, one which favors expanding the program of pumping money into the system with bond purchases, another which favored no change, and a third which wants to use another interest rate increase to stimulate the economy. The lack of a clear plan by the central bank policy makers strikes fear into investors who want to see more of an agreement on the direction of policy.

While we don't trade the Russian ruble, it is part of our BRIC MarketSafe CD (for which time is running out!). Chuck pointed out to me yesterday that the Russian ruble has been the best performing currency of the BRIC, which was surprising. A story overnight said that Russia's central bank will have to accept a stronger ruble next year as rising commodity prices move the currency higher. Strong commodity markets have pushed capital into the Russian markets, pushing the ruble higher. Policy makers had indicated they will try to cap the ruble's gains, but the IMF warned recently that these efforts to fight the rubles advance will prove 'unproductive' and that 'underlying factors' justify the ruble's strength. This is good news for holders of the BRIC MarketSafe. If you haven't purchased this latest MarketSafe CD, the cut-off is approaching - you only have until December 3 and then your opportunity is lost.

OK, to recap, the dollar rallied on carry trade reversals, the 'Audit the Fed' bill is in jeopardy, AUD$ and NZD$ fell, and the BOE is split on the future of monetary policy in England.

Currencies today 11/19/09: American style: A$ .9170, kiwi .7287, C$ .9414, euro 1.4851, sterling 1.6626, Swiss .9811, European style: rand 7.5605, krone 5.658, SEK 6.93, forint 180.17, zloty 2.789, koruna 17.2147, RUB 28.90, yen 88.86, sing 1.3904, HKD 7.75, INR 46.69, China 6.8284, pesos 13.07, BRL 1.7287, dollar index 75.54, Oil $78.77, 10-year 3.35%, Silver $18.20, and Gold... $1,134.55

That's it for today... Best of luck to Chuck this morning as he heads to the eye doctor again today. It is nice to see Kristin Kuchem back from two weeks of traveling. She said both of her presentations were well received, as investors were eager to get money diversified out of the US$! Looking forward to the Blues game this evening, as several of us from the desk are hoping to watch a win! Hope everyone has a great Thursday!!!

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Catching Argentinian Disease

JohnMauldin — Sat, 31 Oct 2009 02:47:00 GMT

Catching Argentinian Disease?
The Ascent of Money
The Independence of the Fed Threatened
A Few Quick Thoughts on the Dollar, GDP, and the Recession
Uruguay, Philadelphia, Orlando, and then...

I have been in South America this week, speaking nine times in five days, interspersed with lots of meetings. The conversation kept coming back to the prospects for the dollar, but I was just as interested in talking with money managers and business people who had experienced the hyperinflation of Argentina and Brazil. How could such a thing happen? As it turned out, I was reading a rather remarkable book that addressed that question. There are those who believe that the United States is headed for hyperinflation because of our large and growing government fiscal deficit and massive future liabilities (as much as $56 trillion) for Medicare and Social Security.

This week, we will look at the Argentinian experience and ask ourselves whether "it" - hyperinflation - can happen here.

The Ascent of Money

I will be quoting from Niall Ferguson's recent book, The Ascent of Money. I cannot recommend this book too highly. In fact, I rank it up with my all-time favorite book on economic history, Against the Gods, by the late (and sorely missed) Peter Bernstein. There are very few books I read twice. There are too many books and not enough time. This book I will have to read at least three times, and soon, and I have a lot of underlines and mark-ups in it already.

If there were one book I could require every member of the Congress to read, it would be this one. As I read it, I am struck again and again by how fragile and yet resilient our economic systems are. Fragile in the sense that governmental policy mistakes, no matter how well-intentioned, can destroy the wealth of a nation, and resilient in that it doesn't happen more often.

In his introduction Ferguson writes, "The first step towards understanding the complexities of the financial institutions and terminology is to find out where they came from. Only understand the origins of an institution or instrument and you will find its present day roles much easier to grasp."

As is often said, those who do not understand history are doomed to repeat it. If you want to understand what is happening in the economy, what the consequences of our choices could be, then I strongly suggest you get The Ascent of Money. It is easy to read, engaging, full of moments where you are led to pull together different ideas into an "Aha!" Ferguson is a brilliant writer and historian, and we are lucky to have this book at a time when it is sorely needed. (order it at Amazon.com)

As I have been writing, the United States in particular, and the developed world in general, are faced with a series of very unpleasant, if not downright bad choices. The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when, or allowing the pain to build up to a climactic event. Today we look at what I think would be the worst choice of all.

Catching Argentinian Disease

At the beginning of the 20^th century, Argentina was the seventh richest nation on earth. It's very name means "silver." "As rich as an Argentine" was a byword. Even after falling from the heights through a series of bad decisions, the country was still so wealthy that, in 1946 when new president Juan Peron first visited the central bank, he could remark that "There was so much gold you could barely walk through the corridors."

Argentina had actually defaulted on its debt in the late 19^th century, not once but twice! But still they managed to avoid destroying the currency and devastating the country. But in 1989, after years of massive budget deficits that were financed with borrowing from abroad and Argentinian citizens, the country was left with so much debt and no one was willing to lend it any more money, that the leaders felt compelled to resort to the printing press.

My Uruguayan friend and Latin American partner, Enrique Fynn, tells me of his experience of going to Buenos Aires and buying a pack of cigarettes one evening. He went into the store the next morning for another pack, and the price had doubled. He came back that evening and the price had doubled again (thankfully for his health, he has quit!). There were no prices on any items in the grocery stores. There was a man with a microphone who would announce the prices of various items, often increasing the price every few hours by 30% or more.

Workers would get their pay in cash and rush to the store to buy anything, as by the end of the week their pay would be worthless. Of course, shelves were empty. The US dollar was king, and could purchase things at amazing prices. I heard stories that were truly compelling. (It made me wish I had gone shopping in Buenos Aires at the time!)

Interestingly, the dollar is still the real medium of exchange. I was told by several people that if you want to buy a house for half a million dollars, you bring the physical cash to the closing. One person counts the money and the other checks the paperwork and title. Argentina has the second largest hoard of physical dollars in the world, only exceeded by Russia. Is it any wonder they are concerned with the value of the dollar?

Let's look at some quotes from Ferguson (emphasis mine):

"The economic history of Argentina in the twentieth century is an object lesson that all the resources in the world can be set at nought by financial mismanagement... To understand Argentina's economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon...

"To put it simply, there was no significant group with an interest in price stability...

"Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy."

Look at the chart below. Using realistic assumptions, It suggests that the annual US government fiscal deficit will approach $2 trillion in 2019. How can we come up with what looks to be about $15 trillion over the next ten years? The Argentinian answer was to print the money.

In the US, the short answer is that unless the US consumers become a massive saving machine, to the tune of 8% or more of GDP and rising each year, and willingly put their savings into US government debt, it's not going to happen. So sometime in the coming years, interest rates are likely to start to rise in order to compensate bond investors for what they perceive as risk. That will bring us to some very difficult and painful choices.

As I wrote a few weeks ago, this scenario could be averted IF the Obama administration produced a credible plan to lower the deficit over time and stuck to it. But today's thought process is about what happens if they don't.

Ferguson pointed out in the quotes above that hyperinflation is always and everywhere a political decision. Governments have to choose to print money. In theory and in practice, what would happen if the Fed decided to accommodate a politicized US government that wanted to spend money on favorite projects and support groups, maybe even deserving programs like health care or defense or pensions or Social Security? Money they could not borrow?

Then Peter Schiff and like-minded thinkers would be right. Once you start down that path, it is hard to stop short of the brink. Brazil got to 100% inflation per month and has really lowered that level over time, but it is not easy.

In such a scenario, you want to own hard assets. Gold. Foreign currencies. Stocks. Almost anything other than the currency that is being printed.

I was asked at almost every speech about that scenario. In Latin America, hyperinflation is not a theoretical issue; it has been reality. More than one person commented on that no one in US economics schools studies hyperinflation. It is required material in Latin America. For many Latin Americans, the dollar has been their safe haven. And now they are worried, with good reason.

For the record, I do not think the US will experience hyperinflation as long as the Fed maintains its independence. Read the speeches from various Fed governors and regional presidents. These are strong personalities, and they understand that going down that path ends in massive tears. Bernanke warned just a few weeks ago that the government needs to get serious about the fiscal deficit. Watch the rhetoric from the Fed heat up after his reconfirmation and the confirmation of two new governors in the first quarter.

The Fed has committed to buy a fixed amount of government debt in its quantitative easing program. That commitment will be finished by the end of the first quarter (if I remember correctly). Then comes the tricky part.

I have been writing for a long time that the main force in the economy right now is deflation. The Fed will fight deflation tooth and nail. But they don't have to buy government debt to fight deflation. They can buy mortgage securities, credit card securities, commercial paper, etc. That will have the effect of easing without encouraging the government to run massive deficits. And such debts are naturally self-liquidating, while government debt is not, at least not in the same way.

I believe the Fed will maintain its independence. Not to do so is to court economic disaster of the first order. These are bright and serious men and women. They get it.

The Independence of the Fed Threatened

The risk is that something changes to compromise their independence. And sadly, there is some risk. Let me quote my fishing buddy friend David Kotok:

"It's now official. The proposed legislation to reform America's financial service supervision includes granting the Secretary of the Treasury a veto over Section 13(3) emergency action by the Federal Reserve Board of Governors. If this becomes law, it will be a sad day for the independence of America's central bank.

"The Secretary of the Treasury, a very senior cabinet position, is appointed by the President and meets with the President in the Oval Office weekly. The governors of the Federal Reserve Board are also appointed by the President. Both cabinet officers and Federal Reserve governors are confirmed by the US Senate. There are supposed to be seven governors; politics has purposefully limited this to five throughout the three-year financial crisis period.

"The Federal Reserve governors are supposed to serve staggered 14-year terms with all seven seats filled. Instead, we have been governed by the present five-member, politically configured board.

"The original seven-governor construction was designed to insulate them from political pressure, for very good reasons. Decades of monetary history throughout the world have disclosed what happens when political influence on a central bank intensifies. The Weimar Republic and Zimbabwe are evidence of the worst inflationary effects of politics. The Great Depression in the US and the nearly two-decade deflationary recession in Japan demonstrate that monetary policy is not only inflation-prone. When central banks are under political influence you can get fire or you can get ice.

"In Japan, the central bank contends with two members of the cabinet sitting in on its deliberations. There is no way to know how much of the last 15 years of deflation and recession is attributable to the inside political pressures placed on the governors of the Bank of Japan. But there is evidence to suggest political influence, especially when you observe how little the Bank of Japan has engaged in asset expansion during this crisis."

This is the nose of the camel under the tent. Starting down this road is very worrisome indeed. I find it appalling that Tim Geithner and Larry Summers went along with this. This is a very clear attempt by the political class to put political pressure on the Fed. I hope the Fed responds with vigor. I can tell you that the officials of whom I am aware will not take kindly to pressure. And that might be an understatement.

(Yes, I am aware of the problems of the Fed being able to decide whom to bail out and why. It is not a perfect world. But better the Fed than Congress.)

All that being said, if the Fed starts to increase its buying of government debt above its initial commitment, then my "optimistic" scenario of a very rough economic patch, which I have been outlining the past few months, is far too rose-colored. I do not think it will happen, but I can guarantee you, I and a lot of other people will be watching.

A Few Quick Thoughts on the Dollar, GDP, and the Recession

Just a few quick notes. When world trade collapsed, so did the need for US dollars, which is what the world uses to transact business. The data looks like world trade is finding a bottom and maybe even recovering somewhat. That means there will be the need for more dollars. And since everybody and their mother are short the dollar, there could be a vicious snap-back rally. I am still bearish the US dollar (and the yen and the euro and the pound) over the long term, but there is the potential for a real rally here.

And my friend Mish Shedlock commented on the US GDP report, which said the US GDP rose 3.5%:

"Today the market is cheering over what is actually an ugly report. A misguided Cash-for-Clunkers added a one-time contribution of 1.66 percentage points to GDP. Auto sales have since collapsed so all the program did is move some demand forward. Government spending increased at 7.9 percent in the third quarter which is certainly nothing to cheer about. Personal income decreased $15.5 billion (0.5 percent), while real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent last quarter. Those are horrible numbers. The savings rate is down, which no doubt has misguided economists cheering, but people spending more than they make is one of the things that got us into trouble. The only bright spot I can find is exports. However, even there we must not get too excited as imports rose much more."

John Williams notes that one-time stimulus or inventory items represented 92% of the reported quarterly growth. The nature of the stimulus-related gains was that they tended to steal business activity from the future. The months ahead are the future. Accordingly, fourth-quarter quarterly GDP change will likely turn negative, again. (The King Report)

And David Rosenberg writes: "Only economists see the recession as being over; the man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go -- and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

"Only 29% of those polled believe the economy has hit bottom -- imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally -- not the onset of a new bull market) has not swayed their view (or ours for that matter)."

Uruguay, Philadelphia, Orlando, and then...

I am finishing this letter in Montevideo, Uruguay. I have been in Buenos Aires, Sao Paulo, and Rio de Janeiro this week. I must say that Rio is beautiful, very green and lush with marvelous beaches, which I sadly only got to drive past. I will come again. I fly back Sunday and am home for a week, then speaking trips to Philadelphia and Orlando. Then my schedule only shows a few days in New York in early December for Festivus with the gang from Minyanville, and Europe in January. I am sure other things will come up, but I am looking forward to being home for awhile.

My friends at International Living have been writing about Uruguay, and I was really looking forward to visiting the country. I have spent a few days with partner Enrique Fynn in this delightful place. Turns out it is the Switzerland of South America. Reasonable bank secrecy laws, and trades zones where you are not taxed on any business you do outside of Uruguay. Many international companies set up their headquarters here. Beautiful beaches, friendly people, and the charm of a small country, plus what will be a brand new airport in a few weeks, which can get you several times a day to any part of the region, directly to Europe, and one hop away from any major city in the world. You can learn more about the country, and other countries you may want to live in or have a second home in, by subscribing to International Living.

One of the laugh lines I use in my speeches down here is that if the Fed actually does start to monetize the debt, I will have to move to Uruguay. I could make worse choices.

Have a great week. I think this weekend I will switch it up from the heavy reading I have been doing and find some science fiction. Reality is way too scary.

Your ready to be in his own bed analyst,

John Mauldin

3rd QTR GDP Is Strong!

ChuckButler — Fri, 30 Oct 2009 14:40:04 GMT

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.

In This Issue..

* Dollar gets sold after GDP report
* High yielders get bought!
* German Retail Sales decline...
* Real has wild swings!

And Now... Today's Pfennig!

3rd QTR GDP Is Strong!

Good day... And a Happy Friday to one and all! I can't believe how hard it rained here yesterday... Unbelievable! And me, with my cane, and not able to run, was stuck in it going from the car... Absolutely soaked! If I were a kid, I would have thought that to be fun! But, I'm not... It's still raining this morning too! UGH! Let's hope it stops in time for the Trick-or-Treaters!

OK... Well the rain fell on the dollar's parade yesterday too! And, just like I thought it would do... The dollar got sold like funnel cakes at a state fair, once the U.S. 3rd QTR GDP report printed... The dollar rally was stopped in its tracks, which meant that the "trading theme" that rewards the dollar when things look bad in the U.S. and punishes it when things look good, which is completely opposite of what it should do fundamental wise, was still in place!

3rd QTR GDP was 3.5%!!! Let's Party! Get on your red dress sweetheart we're going out dancing, we're going to party like it's 1999! Seriously, the Gov't officials, including Summers and Geithner think it's all seashells and balloons from here on out! So, why shouldn't we think the same? I mean they've never led us to the wrong side of the tracks have they? HAHAHA HAHAHAHAHAHA... And HAHAHAHAHAHAHA HAHAHAHAHA!

OK, don't get me wrong here, I'm glad the U.S. economy seems to be out of the recession/ depression... But, didn't we expect a bump in the economy? Didn't we think we would see growth by the end of the year, based on the stimulus and money supply extravaganza that went on the first part of this year? And... Based on the reports I saw, a large portion of the growth was actually a return of Consumer Spending in the quarter... Cash for Clunkers really helped the Consumer Spending along too!

But isn't it just like the people that win the lottery... Suddenly, they have all this cash... And they spend it until they have no cash and voila! They are back to having nothing to spend! That's how I think the U.S. economy will react once the stimulus and other monetary candy is withdrawn from the economy... I'm still pinning my colors to the mast of a double dip for the economy... We've got the first two parts... The negative growth, and now the positive growth... Where are we headed next? Only the Shadow knows!

We'll begin to see a glimpse of what's going to go on in the next couple of weeks, as the Fed's Quantitative Easing program has hit their ceiling of $300 Billion, and ended yesterday... The Fed's 7-month buying spree, remember they announced this plan while I was in Florida at spring training, seems to have put the lid on yields of Treasuries to allow the housing market some time to heal... But, as I told my publisher for the Currency Capitalist, Erika Nolan, when I met with her after the announcement... "the U.S. has just opened Pandora's Box of baaaaaaaaaddddddd things for the economy, for Japan has implemented this same program, but over 10 years ago, look how well that's turned out for them!"

Today's data brings us two of my faves... Personal Spending and Income... We'll see if the Consumer Spending continued in September or not...

There's a great headline to a story on the Bloomie this morning... The title reads: "Obama Bridge To Lasting Economic Expansion Risks Going Nowhere" A Bridge to nowhere... That sounds about right to me! It could be the Bridge Over Troubled Waters, or it could be the Bridge of Sighs... I still believe that the U.S. Gov't has spend Trillions taking us deeper into the abyss of a national debt, with little to show for it, except... The U.S. has ventured into the private sector deeper than any Gov't has before during this financial meltdown... Think they'll get out once it's over? HAHAHAHA HAHAHAHAHA! Not going to happen my friend!

OK, enough of that! It's a Friday for crying out loud, Chuck, can't you think of more pleasant things to talk about? Yes... Let's see... Oh yeah! I started telling you above about the non-dollar currency rally VS the dollar yesterday, so let's go back to that!

Well, there wasn't much to say other than the dollar got sold after the GDP report printed... It wasn't so much that the currencies rallied VS the dollar, as it was a sell off of the dollar, which led to a currency rally! The high yielding currencies of Australia, Brazil, New Zealand, and even Norway now that rate on the rise there, posted the best gains VS the dollar on the day. And that makes sense, right? I mean, haven't I been harping on the yield / interest rate differentials lately? And here's where they came out to play!

The data in the U.S. was good, which brought the risk takers out of the walls once again, and knowing that the U.S. interest rates are going to remain near zero for some time to come, they sold the dollar and those paltry yields that go with the dollar, and bought currencies that had a nice positive yield differential to the those paltry yields!

The Big dog, euro, as the offset currency to the dollar, obviously participated in this dollar sell off... The euro's gains were stopped this morning though, when German Retail Sales printed and unexpectedly declined in September. Remember, Germany's economy exited their recession in the 2nd QTR, albeit a nascent recovery at best... So, we'll have to keep an eye on Germany's nascent recovery to see if it "double dips" too!

Speaking of Brazil... Recently, the real has really shown its tendency to take a walk on the wild side when trading gets going... I'm talking about 3-5% swings good and bad! Whew! That's something to watch! The good news is... That even though the swings in the price of the real are wild, the overall trend continues to be good for real holders... I expect the real to react to rumors this morning that the Gov't will not throw out road blocks to impede the real's performance... That would be HUGE! And very welcomed by currency traders that trade the real always looking over their shoulders to see if the Gov't will throw out the road blocks... So, like I said, there are rumors this morning, that the Gov't will announce that they are not going to impede the real's rise at this time...

And then there was this... U.S. Treasury Sec. Tim Geithner, announced yesterday that he wants the power to not only tell a corporation that they are closed for business, but to also have the power to shrink Corporations that are not having problems! He will be the "death panel" that Barney Frank talked about a couple of months ago for non-financial institutions... Shake me, Wake me, when's it's over... Maybe I'm having a bad dream, folks...

To recap... The dollar's rally was stopped in its tracks by the U.S. 3rd QTR GDP which printed a 3.5% increase, and caused investors to seek higher yielding assets, thus selling dollars. German Retail Sales unexpectedly declined in September, thus stopping the euro from rallying further this morning. And the High Yielders get all the glory when investors realize that U.S. rates are going to remain near zero for some time to come... Aussie, Brazil, New Zealand lead the pack!

Currencies today 10/30/09: A$ .9155, kiwi .7310, C$ .9360, euro 1.4845, sterling 1.6540, Swiss .9840, rand 7.6750, krone 5.63, SEK 6.9875, forint 183.61, zloty 2.8525, koruna 17.83, RUB 29.02, yen 90.90, sing 1.3970, HKD 7.75, INR 47.03, China 6.8275, pesos 13.01, BRL 1.7325, dollar index 75.87, Oil $79.58, 10-year 3.62%, Silver $16.60, and Gold... $1,044.90

That's it for today... I'm writing from home this morning, as I have a doctor's appt. first thing before I go to work... The network was a little touchy this morning, and I wasn't sure I would get this out, but it has settled down now. Whew! Big Weekend for my beloved Missouri Tigers as they travel to Colorado. And my little buddy Alex, as his team travels to Webster Groves! HA! Good news in the local paper this morning, as the best player in baseball today, Albert Pujols announced that he wants to be a Cardinal for life! Our Blues just can't get on a roll, win one, lose one... UGH! So... Tomorrow is Halloween! I can't wait to see the little ones in their costumes! Our little Delaney Grace is Dorothy from the Wizard of Oz, with ruby red shoes, a basket and Toto too! She is so darn cute! I'll leave you with the thought of a little Dorothy coming to your door! I hope it dries out here soon... And I hope you have a Fantastico Friday and Ghoulish Weekend! BOO!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Quarterly Review and Outlook - Third Quarter 2009

JohnMauldin — Mon, 12 Oct 2009 20:32:18 GMT

I look forward at the beginning of every quarter to receiving the Quarterly Outlook from Hoisington Investment Management. They have been prominent proponents of the view that deflation is the problem, stemming from a variety of factors, and write about their views in a very clear and concise manner. This quarter's letter is no exception, where they once again delve into the history books to bring up fresh and relevant lessons for today. This is a must read piece.

Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let's jump right in to the essay.

John Mauldin, Editor
Outside the Box

Quarterly Review and Outlook - Third Quarter 2009

Ponzi Finance

The Federal Reserve reported that as of June 30, 2009 total U.S. debt was $52.8 trillion. Total U.S. debt includes government, corporate and consumer debt. Importantly, however, it does not include a few trillion in "off balance sheet" financing, contingent unfunded pension plans for corporate and state and local governments, or unfunded liabilities of the U.S. government for such items as Medicare, Social Security and other programs. Currently GDP stands at $14.2 trillion, so there is approximately $3.73 in debt for every dollar of output in the United States, a level unprecedented in our history (Chart 1). Normally, debt levels as a percent of GDP would be uninteresting and immaterial; however, the current level of debt is unique in two ways. First, the asset side of the balance sheet purchased by the debt is falling in price. Second, the money that was borrowed to purchase those assets was often fraudulently expended. Neither the borrower nor the lender really expected the debt to be serviced. Rather, each party expected the asset price to rise extinguishing the debt.

This type of financial arrangement was correctly analyzed by the famous American economist Hyman Minsky in his paper, "Financial Instability Hypothesis", in which he described three phases of debt financing. The first is "hedge finance", where the lender expects a return on both principal and interest. The second is "speculative finance" where the lender expects to get interest on the loan but perhaps not the principal. The third case, where the lender expects neither the principal nor interest to be returned, is referred to as "ponzi finance". This was typified in the last business cycle by loans issued without documentation, no down payment home loans, extremely low cap rates on commercial real estate, and the high leverage borrowing ratio of private equity funds. Even ponzi finance works as long as asset prices are rising. But once the bubble is pricked, the debtor is left with declining asset values that preclude the rollover of their obligations.

Presently, in this worst of all post-war recessions we are witnessing the collapse of asset prices that were inflated by the speculation of earlier years. The aftermath of that speculation and its impact on the economy has been thoroughly studied prior to our present business cycle by the economists of yesteryear who marveled at the mania in the collective mindset of private citizens and their elected representatives who produced such bubbles. The most famous of these economists was Irving Fisher (1867-1947), who in 1933 wrote about this problem of over-indebtedness (Irving Fisher, 1933, Econometrica, "The Debt-Deflation Theory of Great Depressions"). He stated flatly that over-indebtedness was the difference between normal business cycles (recessions), which occur frequently through "over-production, inventory misjudgment, or commodity price fluctuations" and extreme business cycle fluctuations (depressions). Based on his analysis of the great depressions of 1837, 1873, and 1929 he outlined a pattern of economic developments that will take place when the debt cycle is broken. Seemingly old news, but it is interesting to apply his sequence of events to today's economic developments as there are disturbing similarities.

A Downward Spiral

Fisher posited that debt liquidation leads to distress selling, contracting bank deposits and declining velocity of money, all of which contribute to the fall in price levels. This accurately describes today's circumstances. Distress selling is rampant, with home foreclosures reaching all-time highs. Additionally, rapidly rising foreclosures in commercial real estate are causing the closing of financial institutions and the liquidation of their portfolios. Money supply (M2), an imperfect measure of bank deposits, is essentially flat over the last six months even though the monetary base is 100% higher than it was a year ago (Chart 2). Further, the velocity of M2 has contracted at a 12.7% rate over the past two years. The Personal Consumption Expenditure Deflator (goods purchased by consumers) has fallen from a 2.7% growth rate 12 months ago to a yearly increase of only 1.3% presently, and appears to be heading for a zero reading in 2010. GDP has recorded its greatest contraction since the 1930's, and probably is not yet at its lowest level for this cycle.

Fisher then noticed that this distress selling would lead to a fall in the net worth of businesses, a decline in profits, and a reduction in employment. Fisher may have been talking about 1929 and the 1800's, but that is precisely our present situation. Despite a 19% gain in stock prices this year, the S&P 500 has declined about 30% from its peak and stands lower than it was a decade earlier. Corporate profits are down approximately 13% on a year over year basis, and in 2008 S&P 500 profits fell for the first time since 1933. The net worth of hundreds of banks and other large corporations has fallen below zero, with some surviving only because of a massive rescue effort by the federal government. Despite these efforts, consumer net worth has fallen, price levels of homes are down about 30% from their peak levels, and business net worth has been impaired by an almost 39% decline in commercial real estate from its peak levels. Industrial production is down 13.3% since its peak, the largest 20 month decline in the post war period (Chart 3). Including potential revisions, the U.S. has lost eight million jobs in this recession, and currently 17% of the labor force is either underemployed, partially employed, or out of work seeking employment.

Fisher seems to be not so historical as prescient. He states that all the above problems create disturbances in the rate of interest, particularly the fall of nominal money rates and the rise of real interest rates. The federal funds rate is now effectively zero, and yet with the steady downward movement in price indices, real interest rates are rising. This, of course, is of concern to debtors.

The uncomfortable conclusion of Fisher's analysis is that major business cycle fluctuations are, in fact, caused by over-indebtedness and the fall in asset prices. Our present situation appears to mirror the exact sequence of events that have occurred in previous depressions. This suggests that our current "great recession" may morph into a more serious and elongated downward business cycle.

The Impossible Promise

The federal government's promise to extricate the U.S. economy from this recession involves more spending (increasing public debt) and more subsidies for consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt. In previous letters we have discussed the fact that the government spending multiplier is zero (read Professor Robert Barro's book, Macroeconomics - a Modern Approach, p. 370). This means there is no long term income benefit from stimulus programs. According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009, "NBER Working Paper 15369") suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.

From a fiscal policy perspective the outlook for economic growth appears to be one of stagnation for several years due to the size of the federal debt, which is expected to rise 35.7% from 2008 levels to 76.5% of GDP over the next ten years according to the Office of Management and Budget (Chart 4). This exercise in government spending is, of course, an exact replica of the Japanese experience from 1989 to the present. Their debt to GDP ratios have gone from about 50% in 1988 to about 178% today, and yet their nominal GDP is no higher than it was 17 years ago, and their employment stands at twenty year ago levels. It is somewhat unsettling that as of the last employment report the United States employed 131 million people, a level that was first reached in 2000, which means the United States has had no net job gains for almost ten years. Indeed, it appears that the fiscal chain around the free market neck is sufficiently onerous to restrain growth for several years. The promise of the government to revive growth through increased indebtedness is, indeed, an impossible promise.

The Hesitant Fed

As Fisher stated, the write-down of debt and distress selling tends to destroy money deposits and lower the velocity of money. Despite the historical evidence of that fact, our current Fed authorities appear to be oblivious to the lessons of the past. Their initial reaction to the liquidity crisis has to be applauded for their heavy work in insuring the liquidity of the financial system. Similarly, the expansion of their bank balance sheet to $2.1 trillion from $1 trillion was the precise reaction needed to counter the emerging deflation of asset prices. However, their actions increased inflationary expectations, and they have encountered a plethora of critics. In responding to this criticism the most recent statistics suggests they are beginning to lose the fight against the deflationary impulses. Consider that the monetary base rose 1000% in the three months ending December 2008, but has been held essentially flat since then (Chart 5).

The Fed's purchases of assets to increase this base automatically created deposits that positively charged the money supply growth to a 15.2% six-month growth rate (Chart 2). If the economy were operating near full capacity, a healthy banking system would take these deposits and multiply them roughly nine times; that circumstance could be inflationary. Unfortunately the banking system is not healthy, as evidenced by the fact that we have closed 95 banks this year, more than the cumulative total of the past 15 years, and another 416 banks are on a list destined to become extinct. With consumers' asset prices falling so rapidly and banks increasingly afraid of failure, banks are more interested in collecting loans than in lending. So with fewer consumers now credit worthy, loan volumes are collapsing. As loans are paid off, deposits are destroyed, and the money multiplier that should stand at nine has gone to zero. This is evidenced by the fact that the six-month change in M2 has fallen to a 1% growth rate, meaning that monetary stimulus is on hold. Get set for negative GDP in 2010.

Dollar Weakness

The inflation outlook from the monetary and fiscal standpoint looks truly deflationary, yet some believe that dollar weakness will reverse this circumstance and create inflation. This is unlikely. First, our imports are about 13% of GDP, and even if the dollar were to halve in value, the price of imported goods would not only have to compete with U.S. producers, but also their price adjustment would have to offset the other 87% of factors included in the pricing indices. Second, unlike the 1930's a 50% decline in the dollar would be difficult to engineer. Fisher recommended to Roosevelt that the U.S. should exit the gold standard, which he did in April of 1933. That was a fixed exchange rate system, and within three months the dollar lost more than 30% against the gold block countries and fell to 60% of its former value within the next five months. This spurred our exports and provided some price inflation (2.9% per year, GDP deflator) for the next four years. Then, in 1937 the tax increases (the next policy mistake) reversed the positive growth rate of the economy and drove price levels and economic activity downward again. However, even with that small period of price increases the overall price level never recovered from the 25% decline that occurred from 1929 to 1933, and thus deflation reigned. Today the declining dollar is a good thing in terms of our trade balance, but the modest change will be insufficient to offset the negative forces of insufficient domestic demand.

Next year the core GDP deflator will fall to zero, with the possibility of negative levels. Likewise, long-term interest rates, which are highly sensitive to inflation, will continue to move toward lower levels. As stated in previous letters, we see no reason why longer dated Treasury interest rates will not mirror those of Japan, which provides a modern signpost for a deflationary environment. Currently the Japanese ten-year note stands at 1.3% with their thirty-year bond yielding 2.1%.

Van R. Hoisington
Lacy H. Hunt, Ph.D.

A New Carry Trade Currency?

ChuckButler — Mon, 28 Sep 2009 14:17:00 GMT

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* 4 BRIC currencies: Brazilian real, Russian ruble, Indian rupee, Chinese renminbi
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In This Issue..

* A bias to buy dollars remains...
* The Fed was warned as far back as 1999!
* Fujii gets "the memo"!
* A ton o' data all around the globe this week!

And Now... Today's Pfennig!

A New Carry Trade Currency?

Good day... And a Marvelous Monday to you! My weekend turned out to be quite grand, as all the things I said that would make it special came to pass! My Cardinals clinched their division. My beloved Missouri Tigers won on Friday night, and my little buddy's 8th grade Flyers won their game against their arch rival... WOW!

Well... Here we go with the last 3 days of September... A month that saw Gold return to $1,000, and the non-dollar currencies all return to levels they held a year ago, having withstood the onslaught of flight to safety trades that benefitted the dollar after the Lehman Bros collapse.

We've seen the Fed Chairman sound the "all clear horn" and me question, why anyone would still be listening to this guy! And our country is becoming quite divided over the health care issue... So... There we have it... September all rolled up in a nice package, to take out the trash!

Ok, we're all caught up now... On Friday, the currencies gravitated toward weaker levels, as the dollar buying continued, with stocks leading the risk assets lower... But it hasn't been a "taken to the woodshed event" for the currencies yet... So, the question remains if this is the correction we've been waiting for or not...

Last week I gave you some quotes by Nassim Taleb, but forgot to tell you that he was the author of the book, "The Black Swan"... Nassim Taleb was talking to a group of business people in Hong Kong this weekend, and asked the same question I've been asking, as he wanted to know why Big Ben Bernanke, and Treasury Sec. Tim Geithner kept their posts after failing to foresee the collapse in global credit markets. Taleb said, "Bernanke, Geithner, and Summers didn't see the crisis coming so why are they still there? Bernanke is like a pilot who didn't see a hurricane."

Good stuff, eh? Especially, when you read the Washington Post and see that the Fed was ignoring pleas from Consumer Groups, as far back as 1999, that subprime lending was expanding... Turning a deaf ear on the Consumer Groups, the Fed left rates low, and accommodating... What the heck do we have these guys for any way! The Fed has been the root cause of every financial problem we've had in this country since they were created in 1913...

OK... Last week, the Financial Times ran a story regarding the dollar laying claims to being the top Carry Trade Currency... Let's read a bit from the FT... "For years, the yen was the currency of choice to fund international Carry Trades. Analysts say negligible U.S. interest rates, its quantitative easing measures and little sing that the country is set to withdraw from its ultra-lose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade."

Well... I had already told you all that, but when you see it in the FT, it obviously gives it more credence, eh?

But, let's talk about that for a minute... If the dollar begins to become the new funding currency of the Carry Trade, that means that people will be selling the dollar short, and using the proceeds to buy a higher yielding asset... Well, in today's markets, there aren't what we would traditionally consider to be "high yielding assets"... For the Carry Trade is quite risky, therefore you need to have some cushion from the "buy side" asset... The only "real interest differential" in the world resides with Brazil... But the real is traded on a non-deliverable forward, which means it's just as liquid as say Aussie or kiwi, which were the main beneficiaries when the yen was the funding currency.

So... This new Carry Trade, might have to wait a bit before getting into 4th gear. When the Reserve Bank of Australia (RBA) begins their rate hike cycle, probably by year-end, then it might begin to make sense... Which is just another thing in the gauntlet the dollar has to run through every day!

Speaking of the Japanese yen... The yen reached a 8-month high of 89.30 overnight. I told you last week that yen is getting a lot of love from Japanese exporters that are repatriating their profits in yen, ahead of the end of the month / quarter.

I had to laugh out loud when I read a story about the Japanese Finance Minister, Fujii, who apparently hadn't gotten the memo about how Finance Ministers are supposed to jawbone the yen lower... Recall, I had told you that he said over and over again that he supported a strong yen... Well... That all changed once he got the "memo"... Fujii said last night that, "people were mistakenly saying he supported a strong yen."

Hey Fujii, got the memo now? Is it clear?... Crystal... OK, now go out there and jawbone the yen weaker, or you'll be falling on a sword!

This week is chock-full-o-data all over the globe... In the U.S. we'll end the week with the Jobs Jamboree, while Japan will print their latest Tankan report (which checks the pulse of the economy), Canada will print their latest GDP, China will print their latest Manufacturing Index, and Australia will report on Retail Sales...

In the Eurozone, Germany re-elected Angela Merkel as chancellor... Now, she just needs to figure out how to deliver those tax-cuts she promised during the campaign!

The euro had climbed back to 1.4720, but the election results were not taken as "euro friendly"... Remember, I told you that there could be tax-cuts coming in Germany, which is the Eurozone's largest economy. Tax-cuts are great, if you are in a fiscal position to do so... Germany has a nascent recovery at best going on right now, so the timing is not what traders are happy with... Therefore the euro dropped like a stone to 1.4570, but then bounced off that is back to 1.4635 as I write...

And the Reserve Bank of Australia, (RBA) which I mentioned earlier was in the news overnight, as the RBA Gov. Stevens gave a speech, that was hawkish... Stevens mentioned that the interest rates needed to move off their "unusually low levels". He also pointed out something that should be quite recognizable by all Central Bankers now, but apparently not here in the U.S.... And that is that "imbalances build up when rates are left too low for too long."

Well... The highly touted G-20 meeting last week ended not with a bang, but with some newfound strength as a group... Recall on Friday I told you that they would replace G-8 as the watchdog for the economies of the world. That news was announced later on Friday... G-20 ended with leaders from the G-20 nations saying that they plan to cooperate on an overhaul of financial regulations to prevent arbitrage in the global system. By the end of next year, banks will be required to hold more capital, and compensation policies will need to be linked to longer-term performance.

You know... When the media reports "Bankers compensation" they're not talking about real Bankers, per se... They're referring to the Merrills and Goldmans of the world that pay out Billions in bonuses, or did at least... Just thought I would clarify that point...

And then there was the British Pound sterling, which I kept saying over and over again, that this dance is gonna be a drag, no wait! I kept saying over and over again, that the pound sterling strength was a house of cards... Well, that house of cards is collapsing under the pound sterling... Even the speculators that were buying it because it was a part of the mix of currencies that made up the IMF's SDR's (Special Drawing Rights), are backing out now...

Data in the U.S. besides the Jobs Jamboree at the end of the week, include the S&P/ CaseShiller Home Price Index for July which will print tomorrow, along with Consumer Confidence, which is expected to be stronger... I guess the people they surveyed haven't seen the Bernanke video collection of his statements that couldn't be more wrong, and still believe him when he says it's all OK! Wednesday brings us the final print of 2nd QTR GDP. Thursday has two of my faves, Personal Income and Spending, and then Friday's Jobs Jamboree...

So, if the data continues to show some strength, but nothing to speak about... I would think that the risk takers will remain confused, and it could lead to further selling in stocks, and other risk assets... Don't really know... Just an opinion on what might happen...

OK, to recap... The dollar has rebounded, but nothing too strong to speak of as of this morning. G-20 is the new world economic watchdog, there's a ton o' data to print this week, all over the globe, and Japanese yen continues to outperform the other currencies VS the dollar.

Currencies today 9/28/09: A$ .8665, kiwi .7135, C$ .9135, euro 1.4650, sterling 1.5870, Swiss .9695, rand 7.44, krone 5.82, SEK 6.9750, forint 184.20, zloty 2.88, koruna 17.22, RUB 30.11, yen 89.30, sing 1.4190, HKD 7.75, INR 47.98, China 6.8274, pesos 13.57, BRL 1.7890, dollar index 76.90, Oil $65.77, 10-year 3.32%, Silver $15.99, and Gold... $992.10

That's it for today... A great weekend, even with the rain on Saturday! It rained so hard that Alex's football game was stopped, and they had to pick it up and finish it yesterday... When I played football, back in the dark ages, we played in any kid of weather... That was a long time ago! It cleared up for a wonderful Saturday night block party with neighbors... Cards are Central Division Champions! (they were picked to finish 4th in this division) Now, it's onto the playoffs... Got to find some way of getting playoff tickets! I'm a month away from heading to Los Cabos, Mexico for the Sovereign Society's Offshore Advantage Academy. 11-4 through 11-7... You can go to www.soveignsociety.com to find out more! I'm flying solo today with the currencies this morning, as Jen is out, so I've got to get working! I hope your Monday is Marvelous!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

The Dollar Gets Ambushed!

ChuckButler — Tue, 22 Sep 2009 14:43:15 GMT

.........But First, A Word From Our Sponsor..........

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In This Issue..

* Non-dollar currencies soar!
* Weber gives the green light...
* Is the Fed buying more Treasuries?
* China considering IMF's Gold!

And Now... Today's Pfennig!

The Dollar Gets Ambushed!

Good day... And a Terrific Tuesday to you! A Tuesday that needs no "turn-around", as the currency actions VS the dollar overnight are amazing! The dollar got ambushed overnight, as the euro shot right straight through the 1.47 handle, and has just traded 1.48! Hmmm... Didn't I say yesterday that the I didn't think the dollar strength we were seeing was any change in the recent trend? ... I love it when a plan comes together!

Traders have found a "soft spot" in the dollar, and are really going after it! I don't recall the last time I saw this kind of a move overnight. It must have been back when the dollar was getting sold like funnel cakes at a state fair, almost every day in the spring of 2008... But, I really don't recall... But, that doesn't put a damper on this morning's move! No way!

The only thing I can think of, or find in the news, that brought about this HUGE move in the currencies VS the dollar, is the fact that European Central Bank (ECB) Council Member, Axel Weber pretty much gave the "green light" to traders, when he said in an interview that the euro's strength is not out of line with fundamentals... That's right! The way I read that is this... It's Central Bank parlance for... "go ahead and drive the euro higher!"

Weber also said, "There were some stronger data coming from the Eurozone compared to some other regions. So, I think that the behavior of the foreign exchange markets is not out of line with these developments over the recent months."

Now... These comments carry even extra weight due to the position Axel Weber holds as President of the Bundesbank... Buba, as I used to call them, is Germany's Central Bank, and has always held a position of influence on the ECB...

So, Axel Weber says the euro's rally is OK with him... That's Big Folks... For, currency traders like to know that they can run up or down a currency and not fear that the Central Bank is going to step in with currency intervention to stop the run. And, for all intent gives them the Green Light...

OK... Now that the euro has pushed the envelope to 1.48, I expect to see some strong profit taking when the U.S. traders arrive... But, keep this in mind... The euro hit 1.48, and therefore, we now know that traders will take it there a few times before they give up... So, if the euro falls back into the 1.47 handle, look for it to bounce, at least a couple of times. I've explained this trading before... It really comes down to how badly the euro bulls want to push the envelope... Or the dollar bears want to push too!

The euro isn't the only currency gaining VS the dollar... Euro, Swiss francs, kiwi, and Swedish krona have all hit 2009 highs overnight, with kiwi gaining to .7215... A quick look at yesterday's currency round-up shows that kiwi was trading at .7040... Using my "new math" talents... That's a 175 pips move! WOW! New Zealand received some very good news on their deficit problem, as their annual deficit fell from 8.1% of GDP to 5.9% of GDP... Still too high, but moving in the right direction!

For once, it seems, the Aussie dollar (A$) followed its kissin' cousin from across the Tasman, kiwi, higher... It's normally the other way around!

You know what I think? I think that the markets are beginning to look at the man behind the curtain at the Fed, and realize he's just pulling levers, and creating special effects...

OK, I'll explain... Yesterday, I talked to you about the "new record" in size of Treasury Auctions will be shoved down the throats of the markets this week, to the tune of $112 Billion worth of 2, 5, and 7 year notes...

Well... I came across this yesterday, from Morgan Stanley...

"Households reduced Q2 Treasury purchases from their blistering pace in Q1 Foreign accounts reduced Q2 UST purchases as the Fed ramped up Q/E ops. Bank Q2 purchases remained anemic."

In normal speak, what that's saying is that Mom and Pop buying of Treasuries has backed off... You may recall me telling you many months ago that Mom and Pop buying of Treasuries had taken up the slack from declining foreign purchases... The Mom and Pop buying was credited to the "flight to safety", when the walls came crashing down last fall...

So... If Mom and Pop buying is backing off, and it was used to offset declining foreign purchases, who's left at the table to buy the Treasury's issuance this week and in a couple of weeks, and a couple of weeks after that?

Well... It's the Fed... I read this, and just couldn't believe my eyes! The Fed is taking on more and more.. I read where it is believed that about 50% of U.S. Treasury issuance in the 2nd QTR saw Fed intermediation... $164 Billion in the 2nd QTR ended up on the Fed's books, while foreigners bought $101 Billion and Mom and Pops bought $29 Billion... When you add in the Primary Dealers, the total of Non-Fed buying was $158 Billion...

Let me be perfectly clear on this... This is only speculation at this point... But it certainly makes sense doesn't it?

Now... Why isn't the main media all over this? Where are the questions about how the upcoming record amounts of Treasury issuance will be taken, and by whom? Why am I the only one asking these questions? It's just little old me (yeah, right! HA!), and my laptop... Oh, and let's not forget that the Administration has already given us the bad news that $9 Trillion in Budget Deficits will need financing in the next 10-years...

This all makes me sick to my stomach... I mean come on! This Deficit Spending has got to stop! And We've got to say NO to any additional new Deficit Spending! Stop it, right here, right now! Cut government in half... Get rid of non-Constitutional agencies... Audit the Fed, and turn this around!

OK... I've got to talk about something else before I throw my keyboard! I used to throw my keyboard, slamming it down on the desk all the time, and break them... The IT people would laugh, and just bring down a new one for me... But, since I got sick two years ago, I don't throw my keyboard any more... But, I was tempted... I could have gone into a song by The Squeeze there, but I didn't...

Remember last week, when I told you about the IMF wanting to get permission to sell quite a bit of their Gold? And at that time, I said... "China, are you ready to buy?" ... Thinking, of course, that China would be the only country that could / would buy up the 403 tons of Gold that the IMF is putting up for sale...

Well... Guess who answered my call? That's right, China! It is reported this morning, that China is considering buying the Gold that the IMF is offering. It's not clear whether they want just "some of the offering" or "all of the offering"... My guess would be the latter... As this would just add to China's goal of diversifying their U.S. dollar reserves...

And... If China does take down 403 Tons of Gold, that will take away from their Treasury purchases, don't you think?

But, I'm not going down that Treasury road again... I'm staying on the high road with Gold! Which at one point yesterday morning, looked weak... I even mentioned on the desk that it looked like Gold was getting spanked, as it was down over $10... But, later in the day, the shiny metal had come back and was on the positive side of the ledger for the day! And now, this news that China is considering buying the IMF's offering of Gold, has Gold on the high road too... Gold is up $12 this morning, back to $1,016!

So... Throwing stones at the dollar this morning on two fronts... The currency and Precious Metals fronts... Hey! I'm not throwing the stones! The markets, traders, investors, etc. are doing the throwing!

You know, each day, when I'm writing the Pfennig, the currencies are all trading, except... The Brazilian real... The real is still not a floating currency, as it goes through a "fixing" each day, but then the markets take it over, and trade it the rest of the day. So... When you have an overnight market like we've just had, when the non-dollar currencies have all spring-boarded higher, I sit with anticipation for the "fixing" for real, and then watch as the markets play catch-up... The move will be stunning, I'm sure... As real is much like South African rand, when it come to the wild swings...

There's not really any data in the U.S. cupboard this morning... In fact, the only thing I see globally is July's print of Canadian Retail Sales... And with it being so delayed, I doubt it will mean much when it does print!

I thought I would play a game of "Remember when?" Here's how it goes... Remember when the Swiss National Bank said they would intervene to keep the franc weak? Or... Remember when the Brazilian Central Bank Gov. said that he would do everything in his power to keep the real above 2? OK, I'll stop there... Oh... Swiss francs? They have gained almost 15%, and Brazilian real? Well, it's trading at 1.82... So let's just say that the "2" thing wasn't in the cards!

So, what am I getting at here? Well... I've told you for years now that Central Bank intervention can stop currency runs for short periods of time only... And that Central Bank jawboning will only last as long as traders want it too, for if the Central Bank doesn't back up the jawboning, then just like a child, Traders will then push the envelope...

OK... Maybe some day we'll play again, only with Big Ben Bernanke!

So... Traders have ambushed the dollar overnight, and Axel Weber has given them the green light to do so. Could the Fed be the major buyer of Treasuries? China may be the buyer for the IMF's Gold sales, and no data today to speak of...

Currencies today 9/22/09: A$ .8740, kiwi .7215, C$ .9375, euro 1.48, sterling 1.6340, Swiss .9775, rand 6.8250, krone 5.8350, SEK 6.8275, forint 183.30, zloty 2.80, koruna 17, RUB 30.12, yen 91.40, sing 1.4110, HKD 7.75, INR 47.96, China 6.8269, pesos 13.30, BRL 1.8240, dollar index 76.13, Oil $70.80, 10-year 3.49%, Silver $17.26, and Gold... $1,017.10

That's it for today... Cardinals' magic number to win their division is 3... Pretty amazing, eh? With two weeks left in the season! Hey, Californians... Did you see the little blurb in the L.A. Times quoting yours truly? Yes, there was a story in the L.A. Times this past weekend regarding "Foreign Currency Investing"... I spend a good amount of time on the phone with the writer, Kathy Kristof, who seemed quite interested in what I was saying! Today, is the first full day of Autumn... YIKES, you and I know all too well what follows Autumn! Oh well, maybe we can make Autumn last longer than usual! HA! So... Welcome to Autumn! And with that... I'll hit send, and get this on the delivery truck to your computer! I hope you can make this Tuesday totally Terrific!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Is The Recession Over? Don't Bet On It

GaryHalbert — Tue, 18 Aug 2009 22:12:00 GMT

IN THIS ISSUE:

Economic Signs of Improvement
Fed Vows to Keep Rates Low
Market Comments from John P. Hussman, Ph.D.
Conclusions

Introduction

We have seen some encouraging economic news in recent weeks, and President Obama and his cronies in the mainstream media have declared that the worst recession in post-war history is all but over. The advance estimate of 2Q GDP was down considerably less than expected (-1.0%); the unemployment rate actually fell slightly in July to 9.4%; and the ISM manufacturing index posted a nice improvement last month.

While these reports were better than expected, and continue to suggest that the worst of the recession is behind us (as I have suggested often in recent weeks), this economy is far from out of the woods yet. Growth prospects continue to look muted, although a growing number of forecasters are suggesting that GDP will register a positive number in the 3Q due largely to the rebuilding of inventories, as I discussed in my August 4 E-Letter.

This week, we will look at the latest economic reports, as well as the Federal Reserve's latest decision on interest rates and purchases of Treasury securities. Also, the Fed says it will end its record large purchases of government agency debt in October. If indeed this happens, it will be the first step in ending the Fed's massive stimulus spending.

Next, so that we don't all get caught up in the latest hype that the recession is over, I will reprint excerpts from a recent Weekly Market Comment written by John P. Hussman, Ph.D. Dr. Hussman is best known as the president of Hussman Investment Trust, and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds, which are actively managed and can go to cash in bear markets.

Dr. Hussman's latest analysis is consistent with the view many of us have that the recession, while improving in some areas, is not over yet, and that the ensuing economic recovery over the next year or longer will be disappointing -- even if there is a bump up in the 3Q. All of this should make for interesting reading, so let's get started.

Economic Signs of Improvement

Over the last several weeks, we've seen some encouraging economic reports. In some cases, "encouraging" simply means that the reports weren't as negative as expected. That was certainly the case with the advance 2Q GDP estimate at the end of June, which showed a decline of only 1% (annual rate) versus pre-report estimates which were considerably worse. Some analysts expect that number to be revised downward somewhat when the second estimate is released later this month.

On the manufacturing front, the ISM Index rose more than expected in July to 48.9, up from 44.8 a month earlier. Industrial production rose 0.5% in July, and construction spending and the factory operating rate both rose modestly last month as well. These are all signs that the recession may be leveling out.

On Thursday of this week, we get the latest Index of Leading Economic Indicators (LEI) for July, and the pre-report consensus is for a rise of 0.6%, following +0.7% in June. If the LEI is up for July, that will mean the fourth consecutive monthly increase. That would be very encouraging and a sign that we will likely be out of this recession by the end of the year.

The US unemployment rate unexpectedly dropped from 9.5% in June to 9.4% in July, as employers slashed 247,000 jobs, the slowest rate of decline in nearly a year. This news temporarily sent stocks to their highest level of the year since the pre-report consensus was for a rise to 9.6%

However, the July decline in the jobless rate came about not because more people had jobs, but because almost 800,000 "discouraged workers" - people who have essentially given up on looking for a job - were not counted as unemployed, thereby allowing the official unemployment rate to fall modestly in the latest jobs report. The number of long-term unemployed people - those who have been out of a job but looking for more than 26 weeks - rose by another 584,000. Thus, it appears we are still headed for 10% employment before this cycle reverses.

Despite the still troubled employment situation, investors welcomed the reports above, and more and more forecasters have apparently decided that the recession is over. I continue to believe that we are still at least a few months from concluding that the recession has ended. The Consumer Confidence Index fell for the second month in a row in July, and retails sales were down slightly last month. Therefore, it is premature to declare that the recession is over.

Fed Vows to Keep Rates Low

To no one's surprise, the Federal Open Market Committee (FOMC) announced last Wednesday that it will continue its policy of keeping interest rates at their historically low levels. The FOMC also maintained its position that interest rates could remain historically low for an "extended period of time." In other words, the floodgates of liquidity are still wide open.

About the only new revelation was that the Fed announced that it will stop buying long-term Treasuries in October of this year. This could be the ultimate case of good news/bad news, in that it's good that the Fed may no longer be printing money to buy Treasuries, but bad in that these securities will soon have to compete in the open market, and this could lead to higher interest rates. Remember that this is why the Fed committed to start buying Treasuries in the first place.

However, the Fed's printing press will not be idle as it said it will continue to purchase up to $1.25 trillion in agency mortgage-backed securities and other agency debt from Fannie Mae and Freddie Mac. The Fed's hope here is to keep a lid on mortgage rates in an effort to stimulate the housing market.

From an economic standpoint, the latest FOMC statement notes that US economic activity is "leveling out," meaning that the rate of descent has slowed. However, this simply means that the recession may not get deeper. The Fed's prospects for recovery, however, were modest, at best. The Fed expects economic activity to remain weak "for a time" (whatever that means) and a return to sustainable economic growth is likely to be gradual.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Market Comments from John P. Hussman, Ph.D.

Dr. John Hussmanis best known as the president of Hussman Investment Trust (a mutual fund family), and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds. Dr. Hussman is also the chairman, president and controlling shareholder of Hussman Econometrics Advisors, Inc. which has published his Weekly Market Comment letters for years, and they always have some interesting points about the economy, the markets, etc.

As a mutual fund manager, Dr. Hussman is somewhat unique in that he not only actively seeks the best opportunities in the stock market, but will also move to neutral positions in his funds during market downturns. In other words, the investment strategies he employs are similar to those used by the active money managers my firm recommends.

The following excerpts are from Dr. Hussman's August 10, 2009 Weekly Market Comment. [Note that we have removed discussions about specific funds where possible.] Pay particular attention to Dr. Hussman's outlook for the economy.

QUOTE:

The U.S. economy lost a quarter of a million jobs in July. Meanwhile, over 400,000 workers abandoned the labor force (and are therefore no longer counted among the unemployed), which prompted a slight decline in the unemployment rate despite the job losses. In the context of an economy still strained by high levels of consumer debt and still record delinquency and foreclosure rates, labor market conditions are still troublesome. Still, the pace of job losses and new unemployment claims has clearly softened from the pace we observed early in the year.

If we knew that this was a standard economic downturn, we might conclude that the recent improvements are durable. However, nothing convinces us that this is a standard economic downturn. As for market action, the major indices have generally been strong, as has breadth (as measured by advances versus declines), but the "investor sponsorship" evident from trading volume has been uncharacteristically dismal compared with initial advances of past bull markets. So here too, we have very strong concerns that the recent advance may not be as durable as investors appear to believe.

All of that said, we aren't inclined to fight even what we view as errant analysis, and the Strategic Growth Fund has about 1% of assets allocated to near-the-money index call options -- about enough to gradually close down about 40% of our hedge in the event that the market advances markedly higher from here, but without putting us at risk of much loss in the event of failure. With investors now anticipating and pricing in a sustained economic recovery, as well as a spectacular earnings rebound, a lot of things will have to go right from here in order to sustain higher prices than we currently observe.

Frankly, our call option allocation here is something of a paean to a notion -- a sustained economic recovery and new bull market -- that I have no belief in whatsoever. But at this point, the broad strength in the major indices, even lacking volume sponsorship or favorable valuation, requires that we allow for the possibility of additional investor speculation. Even if we do observe such an outcome, it's difficult to envision that the S&P 500 will clear the 1000 level for all time, without revisiting it again in the months (not to mention years) ahead. To the extent that we don't clear 1000 permanently, establishing investment exposure here with anything but call options amounts to a game of trying to "ride" the market higher and to get out before it returns to or below current levels. With the market strenuously overbought already, that game strikes me as exquisitely difficult to get right. Hence the use of a modest allocation to call options only, without closing our downside hedges.

Call me skeptical. But if you look carefully at the economic data that shows improvement, and correct for the impact of government outlays, it is difficult to find anything but continued deterioration in private demand and investment. What we do see is a government that has run what is now a trillion dollar deficit year-to-date, representing some 7% of GDP. That sort of tab will undoubtedly buy some amount of Cool-Aid, but it has been something of a disappointment to watch how eagerly investors have guzzled it down. It is not at all clear that short-term, deficit-financed improvement necessarily implies sustained growth in the context of a deleveraging cycle. This is like somebody borrowing money from their Uncle and then celebrating that their income has gone up.

Moreover, it might be enticing to look at a chart of the S&P 500 and envision a quick return to 2007 highs and beyond, but it is important to recognize that those highs were based on profit margins about 50% above historical norms, combined with an elevated P/E multiple of about 19 against those earnings. Even if the economy is poised for a sustained recovery here, the belief that those joint outliers will be quickly re-established goes against historical precedent.

In any event, we've got some call option coverage to gradually allow participation if this run continues.

Post-Crash Dynamics

When markets crashes are coupled with changes in the fundamentals that supported the preceding bubble -- as we observed in the post-1929 market, the gold market of the 1980's, and the post-1990 Japanese market, and currently observe in the deflation of the recent debt bubble -- they typically do not recover quickly. Indeed, the hallmark of these post-crash markets is the very extended sideways adjustment that they experience, generally for many years.

The chart below updates the position of the S&P 500 (red line) in the context of other post-crash bubbles. The horizontal axis is measured in months. Note that very strong and extended interim advances have been part and parcel of similar experiences.

The intent here is not to argue that the U.S. stock market must by necessity follow the same extended adjustment that followed prior burst bubbles. Rather, the intent is to underscore that it is dangerous to infer that structural difficulties have vanished simply because a market enjoys a strong post-crash advance.

My friend James Montier at SocGen draws a similar pattern from a larger historical collection of post-crash bubbles - including the above instances, as well as others such as the South Sea Bubble and the Railroad Bubble of the 1840's. The underlying theme is that the adjustment period following the bursting of a bubble tends to be very extended.

I understand the eagerness of investors to put the entire credit crisis behind them and look ahead to a recovery of the prior highs, but these hopes are based on the assumption that a positive boost to GDP, once achieved, will propagate into a full-fledged recovery. Again, however, no economic improvement is evident in the behavior of consumer demand and capital spending, once you adjust for the impact of government spending (particularly transfer payments).

Yes, we have observed a massive reallocation of global resources from savers (who have bought newly issued Treasury debt) toward mismanaged financial institutions that made bad loans. Yes, there are certainly favorable short-run economic numbers that can be achieved by running a year-to-date federal deficit equal to seven percent of the U.S. economy. The problem is that this money does not come from nowhere. We have effectively sold an identical ownership claim on our future production to those individuals and foreign governments who bought the Treasuries. Government "stimulus" is not free money. The continued attempt to bail out bad loans with good resources (largely foreign savings) will end up costing our nation some of our most productive assets, which will be acquired by foreign countries and investors for years to come.

From my perspective, investors have gotten entirely too far ahead of themselves with the assumption of a sustained recovery. Nevertheless, we again have about 1% of assets in index call options to allow for further market strength if it emerges. I expect that if they move "in the money," we will leave their strike prices unchanged unless market internals deteriorate measurably. Leaving our call option strikes fixed would open us up to losing on any subsequent downturn whatever we make on a further advance, but again, our opening exposure is fairly limited. We'll let the market put us into a more constructive position if investors are inclined to continue their exuberance here. [Emphasis added, GDH.]

Market Climate

As of last week, the Market Climate for stocks was characterized by unfavorable valuation and mixed market action, but enough evidence of speculation (reasonable or not) to own about 1% of assets in index call options. We are otherwise hedged.

During earnings season, there are often days where most of the performance of the Fund is driven by significant movement in a small handful of Fund holdings. These movements can be positive or negative, and may cause the Fund to move differently than one would expect that the Fund "should" move based on our investment position, and on what the market did on a particular day. As I've frequently noted, short-term movements, particularly day-to-day, are not effective indicators of the Fund's investment position, or predictors of Fund performance. Performance is always best measured from the peak of one market cycle to the peak of the next, or over an extended period of years representing neither a peak-to-trough nor trough-to-peak movement in the market.

Based on our standard methodology, which considers normalized earnings (not the far more depressed level of current earnings) the S&P 500 is now priced to deliver 10-year total returns in the area of 6.9% annually. This is a figure that has historically been associated with bull market peaks, including 1969 and 1987. In most instances, such valuations turned out badly in reasonably short order. It is, however, true that prospective returns were even worse prior to the 1929 crash, and during the bulk of the period since 1996, so there have been some historical periods where speculators have driven valuations to higher levels, and during these times, it has not been particularly effective to stand in front of speculators saying ‘no, stop, don't.' [Emphasis added, GDH.]

Ultimately, all of those periods where valuations were driven to higher levels were followed by poor long-term returns, with stocks generally trading at lower levels at some point one or more years later. So we can say with a reasonable degree of confidence that even if the present advance continues, investors will most likely observe current levels again either within the current market cycle or (worse) several years out. Overvalued markets simply do not "run away" for good. Still, it can be painful or at least unenjoyable to remain defensive during a speculative advance.

In bonds, the Market Climate last week was characterized by relatively neutral yield levels and moderately unfavorable yield pressures. As usual, we will tend to increase our bond durations on spikes in yield (weakness in bond prices), and these are becoming more interesting -- though not strongly attractive. Our most recent extension of durations was in the 3.9%-4% area for 10-year Treasuries, and a push materially above that level would represent enough of a yield pickup to move a modest amount of short-maturity Treasury allocations into mid-maturities. As I've noted in recent weeks, we don't anticipate much in the way of extended directional movement in the bond market, so most of our portfolio activity will probably tend to be modest reallocations in response to yield fluctuations. At the point where we observe either fresh inflation pressure or general declines in Treasury yields (i.e. general downward pressure on real interest rates), I expect that we'll observe fresh pressure on the U.S. dollar and upward pressure on precious metals shares. For now, those markets are likely to be somewhat range-bound as well.

We've got an extended economic adjustment ahead. Most probably far longer than most investors presently expect. As always, we'll take our opportunities as the evidence emerges, with the objective of outperforming our respective benchmarks over the complete market cycle, and an additional emphasis on defending capital over the course of that cycle. [Emphasis added, GDH.]

END QUOTE

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

While we have seen some encouraging economic reports over the last few weeks, it is premature to declare that the recession has ended. As discussed above, the unemployment rate is very likely to rise even higher before this cycle is over. Remember that consumer spending is still the main driver of this economy, and retail sales fell slightly in July well below the pre-report consensus. The Consumer Confidence Index fell a second month in a row in July.

On the positive side, the Fed remains committed to keeping interest rates very low for an extended period, and liquidity is plentiful for now. If this Thursday's Leading Economic Indicators report is positive, that will market the fourth consecutive monthly increase, which will be a very good sign that the recession will end by the end of the year.

I agree with Dr. Hussman that stocks are overbought at this point, as many investors who bailed out in February and March are now jumping back in. The stock market has felt like a mini-bubble since the March lows and especially in July. Thus, I would not be surprised to see the downward correction that began last week to continue in the weeks ahead.

Finally, I recently told you about our online webinar featuring the Potomac Guardian Program on August 6th. We had hundreds of investors register for the webinar and it was well-received. If you were unable to attend this webinar but would still like to learn more about the Potomac Guardian Program and its investment strategy, you can now find a recorded version on our Internet website at www.halbertwealth.com.

Wishing you profits in a difficult market,

Gary D. Halbert

SPECIAL ARTICLES

Stocks: Five Key Signals for Investors
http://www.businessweek.com/investor/content/aug2009/pi20090817_099111_page_2.htm

Why Obama's Ratings Are Sinking
http://online.wsj.com/article/SB10001424052970204683204574354383543314054.html

Public Spending's Day Of Reckoning
http://www.forbes.com/2009/08/12/public-spending-finances-economy-debt-opinions-contributors-desmond-lachman.html

Feds Say NO To CIT...

ChuckButler — Thu, 16 Jul 2009 14:40:18 GMT

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In This Issue..

* Currencies have strong day...
* What are the qualifications?
* JP Morgan posts 36% increase in earnings...
* RBA attempts to keep A$'s in check...

And Now... Today's Pfennig!

Feds Say NO To CIT...

Good day... And a Tub Thumpin' Thursday to you! The first day this week that I've gotten up and to work at my normal time. I hit the wall yesterday afternoon, went home, watched about 10 minutes of the Wizard of Oz (my all-time fave movie) with granddaughter Delaney Grace, and then went to sleep! Crazy, I know, but when you hit the wall, you hit the wall!

Yesterday was a strong day in the currencies. I wrote yesterday about how the euro was inching toward 1.41, but the level had been a tough row to hoe, with the euro giving back ground each time it went higher than 1.41... And... That was the case yesterday! The euro did trade higher than 1.41. It was 1.4120 when I left the office! But, as I turn on the screens this morning, the single unit has fallen below the 1.41 figure...

I think we'll probably see a day when the Risk Aversion campers come back out to play, given the news on CIT... The lender, CIT, was told that they would NOT receive any Federal assistance... (I guess they didn't have any ex-Goldman Sachs employees at CIT!) This news has pushed stock futures down this morning, and the "risk" of yet another bankruptcy that could shake the market is on the table. You know me... I would prefer that the Gov't was not involved in all this, so on one hand, I'm not sorry that CIT will not get assistance... On the other hand though, it really raises the question as to just what are the qualifications to receiving federal funds? Because Lehman Brothers, (Goldman's biggest competitor at the time) didn't qualify... But AIG did... Of course AIG owed Goldman a ton of money.. Maybe that's the qualification! Oh, I'm not going to get started on all this, I'm sure there are all kinds of stories going around for you all to read that would keep me out of the hot seat with the legal beagles!

So... If the Risk Aversion campers come back out to play today, that means we could see pressure on the currencies once again... Unless... Yes, unless we saw a break of the link with stocks and currencies... And then traders and investors would look at the fact that the "green shoots" are nothing but dandelions, and the U.S. fundamentals are rotten, which will cause more deficit spending, more dollar printing, more monetizing debt, and all the other things that should, fundamentally speaking, weigh heavily on the dollar!

All of the currencies, except yen, are off their highs of yesterday this morning. With Risk Aversion back on the table, Japanese yen is rallying again... This going back and forth from one day to the next is really beginning to give me rash! I'm tired of it! I'm also tired of writing about it!

OK, did you see the results of the FOMC's meeting minutes yesterday? In case you didn't, the minutes read like a book from the fiction section of the book store... The Fed revised up growth for the rest of this year and next year. Although the Fed raised their growth forecast... they raised the expected ranges for the unemployment rate through the forecast. So... What I took from the minutes is that the Fed doesn't believe the unemployment problem will begin to seriously reverse itself until 2011...

So... I just don't know where the growth will come from... And yes, I'm very well aware of the fact that labor is a lagging factor of growth... But with 1 in 5 people unemployed, I don't see where the growth will come from... Do you?

Oh... And U.S. Foreclosure filings hit a record in the first half of 2009... More than 1.5 Million properties received a default or auction notice or were seized by banks in the first 6 months of this year... That's a 15% increase from 2008's first half... One in 84 U.S. Households received a filing... But the Fed see's growth? Maybe if this data was showing a bottom... But from what I see, it is much like house prices still searching for a bottom...

Speaking of the Fed.. I read this in the Wall Street Journal...

"More than 175 prominent economists are warning that "the independence of U.S. monetary policy is at risk" because of attacks on the Fed. They are urging Congress and the president to "avoid compromising [the U.S. central bank's] ability to manage monetary policy as it sees fit" and to refrain from politicizing its decisions on emergency loans to financial institutions.

The move to publicly defend the Fed's role reflects growing unease among academic economists, former Fed officials and some investors that the vehemence of the criticism from Congress of the Fed's handling of the financial crisis suggests a readiness in Congress to weaken the freedom the Fed has to move interest rates as it see fits."

Hmmm... I would like a list of those 175 prominent economists so I can give them a piece of my mind! While the Fed is "supposed" to be independent, its mere existence is questionable at best! Why not let the markets decide what interest rates should be? Again, though, I won't get into all this deeper, because, it would take over the entire letter for weeks! I just thought I would throw it out there and see what it hit...

Ok... Remember last week when I told you how June is normally a "good month" for the Budget Statement here in the U.S.? Well... For the first time since 1991, June was a deficit for the Budget! The Budget Deficit was $94.3 Billion in June! OUCH! Hey! Don't we normally see quarterly tax returns to keep the Budget Balance from turning to a deficit in June? Why yes, Chuck, we do... Or... DID! Not this year, folks... And probably not next year either! Tax receipts fell 17% (year on year) in June... And for all of you keeping score at home... For the year so far... Revenues are down 17.9%, and expenditures are up 20.5%... Not a good formula, eh?

Have you seen the results of the first set of earnings reports this week? Goldman and now JP Morgan reported some nice earnings... That's nice, eh? I say that with my own style of facetious tone!

I'll say this... You can scrap what I wrote about earlier that the Risk Aversion campers will come out to play today because of the CIT verdict... That's because JP Morgan just announced a 36% increase in 2nd QTR earnings! And you should have seen the currencies turn from red to green! The euro is back above 1.41... See how fickle these traders are? They can turn on you in a NY minute!

The JP Morgan earnings will have to hold fort on the markets forgetting about CIT, until more earnings announcements come out... So far, the "banks" have surprised me on their earnings...

I really do think that if we could put all this back and forth behind us the euro would move 3 to 4% higher, and then wait to see what happens then... But, that's a BIG IF...

Today, we'll see the Weekly Initial Jobless Claims, which really dropped last week... I had the thought when I saw the figure drop last week that maybe we've saturated the layoffs... In other words, maybe, Corporations are getting pretty close to not being able to cut any more jobs... It's a thought...

We'll also see the color of the TIC's data (Treasury International Capital) or... What used to be called the Net foreign Purchases report... The TIC's data will be May's print, and is expected to remain quite low, thus not covering the required amount of purchases to finance the Current Account Deficit... Which means, the financing gets shoved to next month... We keep shoving this all down the road... Just like everything else... We'll let someone else deal with it in the future... That's so sad! My friend, Bill Bonner, talks about this, in the award winning movie, I.O.U.S.A. Bonner recalls that Thomas Jefferson called it "immoral for one generation to load up the next generation with debt."

But, we go on about our lives each day, without worry about what we are doing to future generations... Again... I had better stop there before I go off on a tangent so long you could grow a beard while reading! HA!

I received an email yesterday responding to my discussing the increase in taxes on the wealthy... Just like I said in the Pfennig yesterday, where you stand on this all depends on what pain you'll receive... I did see that in most states, the taxes would go above 50% to pay for the health care...

And then there was this... I see where the Reserve Bank of Australia (RBA) sold A-dollars
(A$) in June... Hmmm... I said a few weeks ago that I didn't think the RBA was selling A$'s to keep a lid on the currency, but merely evening out the flows... But now, the June total was A$1.9 Billion of its own currency, sold...

I've now changed my mind on this... I believe the RBA is attempting to keep the A$ around 80-cents, given the global recession and everything else going on the financial markets, the RBA probably sees a real problem with a soaring A$ at this point. While I never like a Central Bank selling their own currency... I can't say that I blame the RBA here... They have one of the best stories going around regarding a currency, and if left untouched by the RBA, the currency could be soaring right now, which would in normal times be OK with the RBA, but in current times, is not OK with the RBA... So...

Until the markets decide they want to push the envelope with the RBA on keeping the A$ around 80-cents... That's where it will remain... But... Should the markets decide to push the envelope and test the RBA's mettle, then 80-cents will be left in the rear view mirror... Unfortunately, and I've talked about this before, today's currency traders don't have the cajones to fight Central Banks any more...

Currencies today 7/16/09: A$ .8015, kiwi .6460, C$ .8940, euro 1.4115, sterling 1.6450, Swiss .9325, rand 8.10, krone 6.3675, SEK 7.7770, forint 193.50, zloty 3.0350, koruna 18.3420, yen 93.90, sing 1.4510, HKD 7.75, INR 48.70, China 6.8311, pesos 13.57, BRL 1.9330, dollar index 79.38, Oil $60.95, 10-year 3.59%, Silver $13.27, and Gold... $939.50

That's it for today... And for me, for 2 weeks! Yes, I'll be gone, first to Vancouver, and then when I return, I'll be heading down the road on vacation with my family. Before I got sick two years ago, the Butler family would pack up our camper and head to Southwest Missouri for a vacation. My kids love camping! So, it's a week of relaxation for me. No cell phones, no laptops, no communication, as we are very deep in the Ozark Mountains! This will be the first time since I got sick two years ago, that we'll attempt camping again... Chris will be kind enough to take the conn on the Pfennig for me. I will send updates from Vancouver, but not from vacation... Speaking of Vancouver, getting there, and getting out are awful things to have to go through, but while I'm in Vancouver, it's an awesome city! Ok... Back to getting this out on time! YAHOO! It's time to make this a Tub Thumpin' Thursday!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Increasing SDR Issuance...

ChuckButler — Thu, 25 Jun 2009 15:17:40 GMT

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In This Issue..

* Fed confuses markets, risk assets get sold...
* SNB intervenes to stop franc's rise
* ECB issues 12-month liquidity...
* Bernanke to get grilled?

And Now... Today's Pfennig!

Increasing SDR Issuance...

Good day... And a Tub Thumpin' Thursday to you! Yes, I know the currencies and commodities got whipsawed yesterday, and my Cardinals got spanked, but that's no reason for us to not enjoy a Tub Thumpin' Thursday! Every day is a gift, and it has nothing to do with stocks, bonds, currencies, and commodities!

OK... Not that I try to be philosophical, sometimes it just comes out that way! Besides, you don't want to think that I'm just a smart *** all the time! HAHAHAHAHAHA!

Well, as I said in the open, the currencies and commodities got whipsawed yesterday, and the culprit was the FOMC minutes... You see, the Fed Reserve met to discuss rates, and other items. And what they said just blew away the bond vigilantes, and really ticked off the Hawks, but in the end, what they said, was really that things will remain status quo...

Their announcement of bond buying didn't measure up to what the bond folks wanted to see, and their announcement that interest rates won't be going up for some time, didn't measure up to the inflation Hawks, who wanted a comment about fighting inflation. Instead, what they received was more Alfred E. Newman on inflation... "What, me worry?" That's how ridiculous their statement was folks... The Fed still looks for inflation to "remain subdued for some time"... Although... Their outlook for the economy was slightly upbeat...

So... If your confused about what the Fed is thinking... Then join the rest of us! The markets spent the day trying to sort it out, and when it was all said and done, they couldn't, so they sold risk assets... So... The 1.41 level the euro enjoyed yesterday morning when I signed off, is now 1.3945...

On top of all this, the Swiss National Bank (SNB) has issued a communiqué' that talks about their "new aggressiveness" toward Swiss franc strength. Now, isn't that just one of the most ridiculous things for a Central Bank to say about it's currency! Would someone over there at the SNB, please think about what you're saying!

Oh well... This is all I'll say about the SNB... It's hard to soar with the eagles when you have to work with a bunch of turkeys! OH! And it's also reported that this "aggressiveness" showed up as intervention by the SNB yesterday... They sold francs in the markets... UGH!

OK, let's get back to the Fed, and their bond purchase program / Quantitative Easing / monetizing the debt / money printing... It's all the same... Oh, one more thing, it's the road to ruins, but don't let that get in the way of the Fed Party! You see, the Fed didn't announce anything this time, because all the world was watching and waiting for them to announce a "mega-buying program"... I told you earlier in the week to NOT expect the Fed to announce any changes to their road to ruins at this meeting, but instead the August meeting, when during the dog days of summer, when almost every #1 trader on earth is on vacation...

So... The bond vigilantes who want bond yields low realize, with the amount of supply that the Treasury is issuing these days, that the only way to get those lower yields is to have the Gov't buying bonds!

I came across something yesterday, that I yelled across the desk to make certain everyone knew... Recall at least a month or so ago, I told you how China had called for a new reserve currency, replacing the dollar with SDR's (special drawing rights), which would be a basket of currencies. This news received a ton of publicity... But one thing that didn't receive a ton of publicity was the fact that President Obama agreed at an economic summit in London that SDR's should now be used to help stabilize the balance sheets of nations struggling to combat the current crisis.

Now... On the outside that looks harmless right? Just helping these struggling nations... But! Could this also be a baby step toward a global currency? Could this be a baby step toward a further devaluation of the dollar, and it's signed off on by the President?

OK, now here's the thing that really caught my eye... The IMF is going to issued $300 Billion worth of SDR's. That's 10 Times... That's right, I said 10 Times the amount of SDR's that CURRENTLY EXIST!

Could this be the facility for China to quietly exchange dollar reserves for SDR's? Come on! Somebody has got to see this the same way I do!

I mean, it was just LAST WEEK, that the countries of Brazil, Russia, India and China (BRIC's) called for a "more diversified international monetary system?" Why, yes, Chuck, it was... Just last week! And then this week, the IMF "just happens" to be issuing 10-TIMES the amount of SDR's that CURRENTLY EXIST! Hmmmm...

I probably should stop there... I'll be accusing people of all sorts of things if I continue on this path... But there's some food for thought, eh? You won't see this on TV... They have more important things to show you and talk about, like... The President killing a fly! That's a really sad thing, to think that our news has come to that!

OK... New Home Sales for May dipped lower, but the inventory of homes for sales also dipped... And, we got the surprise of year when Durable Orders for May showed an unexpected and very strong gain of 1.8%... While I think this is wonderful news, I have to question it... I mean, with the automobile industry basically shut-down, one would think this number to be quite lower... However, I'm told... That non-defense aircraft orders more than offset the auto losses. OK, so, this is NOT a green-shoot folks... This is a One-and-done!

OH! And to follow up on yesterday report regarding Existing Home Sales... I totally forgot to mention that Foreclosure Sales are soaring, and thus a big part of the rise in Existing Home Sales... So, no green-shoot here either!

Today, we'll see the Weekly Initial Jobless Claims, and... The Final print of 1st QTR GDP, which will remain at -5.7%...

So, once again, not much on the data watch for today.

Before I go to the Big Finish... I want to follow up on the news I wrote about yesterday regarding the European Central Bank's (ECB) EUR 300 Billion injection of liquidity out 12-months... The total came in at a higher figure than that, at EUR 442 Billion... Still, much lower than the forecasts, which had seen some call for a number as high as EUR 1 Trillion! And... This morning, the Eurozone announced that Industrial Orders fell 1% in April... So that data isn't helping the euro any either!

And then there was this from the NY Times this morning... "The U.S. House Oversight and Government Reform Committee will question Federal Reserve Chairman Ben Bernanke about his role in Bank of America's acquisition of Merrill Lynch. While Republican lawmakers are launching an attack on Bernanke, who is Republican, Democrats are defending him."

Man, is that all mixed up! But... A week ago or so, we were getting reports about the Bank of America (BOA) purchase of Merrill Lynch... And now, nothing, absolutely nothing, say it again! Any wonder why? Well, maybe it will come out in the U.S. House Oversight and Government Reform Committee questioning, although I doubt it...

And the State of California... The largest economy in the U.S. and in the top 7 economies of the world (used to be 7th, but with their recession, who knows?), announced that they were going to pay their bills with IOU's... The state's controller said. "Next Wednesday, we start a fiscal year with a massively unbalanced spending plan and a cash shortfall not seen since the Great Depression."

And... The Fed believes the recession is easing? Hmmm... Maybe they are too far away from the California books and records!

I'm on a roll here, somebody stop me! OK, I'm stopped!

The Treasury will auction $27 Billion of 7-year Treasuries today... Just keep the supply spigot open must be the Treasury's motto these days!

Currencies today 6/25/09: A$ .7955, kiwi .6360, C$ .8605, euro 1.3940, sterling 1.6280, Swiss .9095, rand 8.0775, krone 6.5170, SEK 7.9350, forint 199, zloty 3.24, koruna 18.72, yen 96.40, sing 1.4575, HKD 7.75, INR 48.65, China 6.8345, pesos 13.27, BRL 1.9705, dollar index 80.78, Oil $69.05, 10-year 3.69%, Silver $13.86, and Gold... $934.20

That's it for today... Draggin' the line today, late night with my little buddy Alex's baseball game. A ringing double and single with two RBI for Alex last night, in his last game of the year. HEY! How about the U.S. National Team, beating Spain in soccer / football? WOW! It's been a while since the U.S. beat a ranked national team. So good for them! No breakfast sandwiches today for the boys and girls, as out little Christine is on holiday... Yay for her! She normally picks them up and I buy, but I forgot to do both this morning! UGH! 11-0 spanking by the Mets last night, leaves the Cardinals only 1 game in front in their division... Well... I'm going to attempt to have a Tub Thumpin' Thursday, I hope you do too!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837