The wonderful inflation/deflation discussion in the previous post inspires me to continue the topic.
Something very important happened yesterday. The dollar made a very clear double-bottom, which will prevent any further decline for at least half a year, and half a year is a long time. Well, unless something extraordinary happens.
So why is that? We know that US is aggressively reducing interest rates while there is a lot of places in the world that do fight the inflation, so borrowing cheap and lending abroad should press the dollar down. I think that to move the currency it is insufficient to have the interest rate differential – you need to physically move money and open carry trade positions. And so far the banks show very little interest to do that. Yesterday banks borrowed only $6.7 bln at 2.6%, which resulted into $11 bln drain. Today they are borrowing only $5.5 bln at 2.3%, another drain. Can you imagine that the banks are refusing to borrow above 2.3%? It’s a strike, a real strike.
There was a question in the comments section – why banks are refusing to borrow while they have record low cash reserves? The answer is simple – those are different banks. Those banks who refuse to borrow above 2.3% do not lend money to those that run low at cash reserves.
So, can the Fed just inflate away from the problem? Reading the comments section it seems that the Fed has no legal mechanism to inflate the currency. Back in time when dollar was backed by gold it was possible for the system to exchange some assets for gold abroad and use this gold to reflate the dollar. But in the fiat currency system the gold doesn’t matter and the Feds have no legal basis to print money. They will do that if the congress allow them, but so far I’m not aware of any movements in the congress to allow printing the money.
So why I think the dollar goes up, at least for now? Remember, the liquidity in the system exists in two forms – money and debt. Money is claim for goods, debt is claim for money. When lenders are refusing to extend the expiring credit lines the borrower is scratching in his pockets to meet his obligations, which usually means selling assets. So the price of all assets is falling against the dollar, or you can phrase it that the purchase power of the dollar is rising. And the price of some assets is falling below the perceived fair value, which makes the dollar a particularly interesting currency – it’s not that piece of paper it used to be when pretty much any asset used to outperform cash
Cash is king (our generation forgot what it is)
February 6, 2008 at 11:13 am
The US debt securitization market that currently undergoes massive credit bubble deflation represents a massive synthetic short against the dollar. Its unwind is dollar bullish.
February 6, 2008 at 1:32 pm
I hope I can figure out when the debt securitization market is finaly written off. That ought to mark the high of the USD for a long time.
February 6, 2008 at 1:57 pm
Btw, I hope you all noticed the panic at CMBX swaps market at markit.com? The LCDX is falling too, CDX is so-so and ABX is holding so far
February 6, 2008 at 2:08 pm
Another blogger covered this:
The Dollar Smile Theory
There was also a recent article on Bloomberg about dollar bulls:
Bernanke Makes Bulls From Dollar Bears Seeing Growth
It certainly goes against the conventional wisdom, which just as certainly isn’t always right. But I just could not bring myself to go long the dollar right now.
February 6, 2008 at 2:12 pm
follow those every day…
Including ITRAXX Credit default swaps for Europe and Japan……
Europe blowing out over past four days….
February 6, 2008 at 2:19 pm
Here’s my thinking:
Over the short-term, $ may strengthen if we see a sharp sell offs in the markets around the world. Money deployed in emerging markets will come back to US making $ stronger.
The only exceptions might be – JPY and CHF. Other could be – Gulf countries, but if oil takes a hit with US recession fears then I don’t see those currencies strengthening against $.
This could happen over the next 6-9 months and might stay like that for a year or so after that.
And that could be the best opportunity to get out of $.
Over longer term, holding $ is BAD. Do it at your own risk.
(Disclosure: Long JPY and CHF.)
February 6, 2008 at 5:23 pm
I’m curious as to your TA here. Could you kindly point out what makes the present apparent double bottom better than the [not-really] double bottom at 84 in May of 2006 or the [not-really] double bottom at 80 in July of 2007?
BTW, whenever Jim Sinclair comments on the USDX chart, he calls it “the worst chart since Enron,” and then draws about six dozen neck lines all over it.
I also note that the USDX is the closest to a fractal chart that I have found. The 1M, 3M, 6M, 1 YR, and 2 YR charts all look the same!
Finally thanks to your commenters for cautioning me last week not to try to play the counter trend rally. I came to my senses and switched back short. Now I am in harmony with Thanatos.
February 6, 2008 at 8:32 pm
theroxylandr wrote:
“Today they are borrowing only $5.5 bln at 2.3%, another drain. Can you imagine that the banks are refusing to borrow above 2.3%? It’s a strike, a real strike.”
Don’t banks need a mininum non-borrowed cash reserve to lend? On the flip side, to borrow, they need to have collateral that the Fed is willing to accept.
Consider that at least some banks, such as Citi, UBS, Merril, have turned to Soveren funds and are willing to borrow with interest rates above 10%. This seems rather strange. They are willing to borrow at extremely high rates from overseas investors, but refuse to borrow near rock bottom from the US Fed. Does anyone else see this as a conundrum?
theroxylandr wrote:
“They will do that if the congress allow them, but so far I’m not aware of any movements in the congress to allow printing the money.”
I think Congress will do the printing, but I don’t think there are any caps on Fed Treasury purchases (Repo’s).
theroxylandr wrote:
“When lenders are refusing to extend the expiring credit lines the borrower is scratching in his pockets to meet his obligations, which usually means selling assets. So the price of all assets is falling against the dollar, or you can phrase it that the purchase power of the dollar is rising.”
Not all assets are falling. Commodities such as food and energy have remained strong. Since the summer of2005 housing prices have fallen steadly, but food and energy prices continued to rise steadly. As long as severe droughts remain in place, food prices will remain high or will increase. Energy prices may fall, but demand will remain strong even in a recession. China and india will likely continue to produce new cars even in a bad recession (ie the Tata Nano $2500 car)
While the dollar’s decline has paused, I would bet on further declines come this spring or by the early summer. I am at a loss, why the dollar’s decline has paused, since I see no indication why investors would consider the dollar a safe risk.
The dollar depends on economic growth for support. While FCB’s are probably not going to be dumping the dollar, they probably aren’t going to be eager to extend more credit to the US. Without Credit expansion, investors will likely seek investment outside of the US. Businesses will likely shun real investment in the US because US consumers are over their heads in debt, and a recover is years in the future. One hand we have the US which is overextendad and deep in debt, including consumer, and gov’t and business. On the other hand, we have all these Asia and Middle east exports sitting on a mountain of cash. Where do I go?
If I was a major business I would go to regions where consumers have cash, Such as Asia and the Middle East. Even if the dollar declines by half, its still doesn’t make sense for me to set up production in the US because:
1. US tax rate is bound to rise. If not at the federal level, but at the state and local gov’t levels.
2. The US has worker rights and minium wage, and I need to provide benefits to US workers. I don’t need to worry about this overseas. (ie significantly lower labor costs)
3. Little to no environental regulation. I can dump PCBs, heavy metals, etc into rivers, and pollute the air.
4. Little to no unionization of workers.
5. Lower transportation costs. Its expensive to ship goods half way around the world. If produce locally my transportantion costs are very low.
6. Reduced setup costs. Four walls, a roof and a dirt floor works fine in India and China (if you ever visit a factory in China it is literally four walls, a roof and dirt floor). Most US manufacturing is now highly automated because labor costs are high. Overseas, I don’t need to invest in high automation (very low start up costs). If I need to cut production, I just cut workers at no cost. I can’t do that if I financed 100 Million in automation equipment. To expand or contract production I can either add or remove workers (PayGo). Vast, Cheap and unregulated labor will maximize my margins, while reducing my risks and overhead costs.
Shankar Khadye wrote:
“Over the short-term, $ may strengthen if we see a sharp sell offs in the markets around the world. Money deployed in emerging markets will come back to US making $ stronger.”
Consider that a sell-off of markets could mean deflation, causing foriegn currencies to appriecate instead of declining. For foriegn currency to devalue against the US dollar, they would have to sell off their currency and buy US dollars. Just like Japan has been doing for decades. While Japan may do this, I don’t believe China, India, or the Middle East would follow in Japan’s footsteps.
February 7, 2008 at 1:31 am
“They are willing to borrow at extremely high rates from overseas investors, but refuse to borrow near rock bottom from the US Fed. Does anyone else see this as a conundrum?”
Well, once again we have to define, which banks. It would be very odd if the SAME banks that refused low ball rates from the fed are the very ones taking sky high rates from SWF’s(?!) This would truly be a conundrum for the ages. We know that Citi is a recipient of SWF cash, and is also a discount window beggar, but I’m not sure about the TAF.
TechGuy, I must confess that I am consistently astounded (and humbled) by your analytical prowess.
February 7, 2008 at 3:08 am
I think old rules no longer hold true in today’s globalized economy.
February 7, 2008 at 3:33 am
Wanted to let you know how much I enjoy your blog. I had a couple questions for you, if you wouldn’t mind sending me an email at
epicwinter@hotmail.com
thanks
-Ryan
February 7, 2008 at 11:54 am
Plantagenet, I am bad in TA, so please fix me with your chart whenever you have time.
I want to stress that I’m not predicting the $ rally. I’m only saying that I suspect it’s not going to tank down in the next 6 months. This is not the same.
As usual, I make posts to test my ideas, sometimes they are so wrong that a violent correction from several people is necessary. Which helps me to steer my mind in the right direction.
About C – I suspect they don’t have good collateral and they feel some shame to bid crappy collateral right in front of 19 friends. Moreover, they’ll have to bid every 3 days, because those auctions are very short-term. They better borrow at anonymous TAF.
February 7, 2008 at 12:12 pm
“But in the fiat currency system the gold doesn’t matter and the Feds have no legal basis to print money. They will do that if the congress allow them, but so far I’m not aware of any movements in the congress to allow printing the money”.
I’m sorry but this administration does a lot of things that are not allowed – with or without congress
February 7, 2008 at 12:13 pm
The US financial sector will no longer be the center of world wide finance. Similiar to Japan in the early 90’s after it’s RE and equity markets crashed, money looked went to other venue’s for a better return. The emerging markets really have two very different stories one is the economy itself and the other is the equity markets that have been jacked by Hedge funds and financial PR.
While the attention is now focused on American consumer demand, bank balance sheets and other financial sector weakness, the real story will be the cost of oil production and its short and long term effects on world wide economic growth.
Most of what we consider considered growth here and abroad has been done with considerable energy costleverage with cost of new oil production @ $80 barrel those days are quickly fading.
February 7, 2008 at 7:03 pm
What does today’s treasury auction do, if anything, to your opinion of the dollar?
February 7, 2008 at 7:33 pm
TLT (long-term treasuries) is at very critical trendline and today was the biggest drop in 4 years.
The treasury has to finance this $170 bln dongy-pongy and they will need to drain a lot of money out of the market.
I wonder if Bernanke is scratching his head?
February 7, 2008 at 7:37 pm
That Guy Drinks Beer – I’m thinking about that (see comment above).
That will test the foreign central banks patience, that’s for sure. But they have that patience.
But on the internal market it will drain cash and raise interest to dollar.
In sum, it is beyond my skills to even guess what will happen 🙂
February 7, 2008 at 7:55 pm
April 2005: MBIA Inc. (NYSE:MBI) announced today that the Company has purchased over 3.4 million shares as part of its buyback program in the first quarter of 2005. The Company has approximately 7.4 million shares remaining in the share buyback program, which was authorized by the board in 2004.
http://findarticles.com/p/articles/mi_m0EIN/is_2005_April_4/ai_n13502462
February 2008: MBIA Inc., the world’s biggest bond insurer, raised $1 billion by selling shares at $12.15 each in an effort to protect its AAA insurance rating.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aunEikXyx0WA&refer=home
I’m too lazy to calculate how much they lost on that.
February 7, 2008 at 7:57 pm
P.S. I sold some of my treasury bonds last week
February 7, 2008 at 8:10 pm
“TLT (long-term treasuries) is at very critical trendline and today was the biggest drop in 4 years.”
The MSM take on this is that China didn’t participate due to New Year festivities and their market was closed. Any truth to this or is it just spin?
February 7, 2008 at 8:25 pm
In sum, it is beyond my skills to even guess what will happen
If they want to attract foreign money to these auction, or need to (which is more likely), rates will have to rise.
I would guess.
I’m too lazy to calculate how much they lost on that.
Maybe you’re not too lazy to think about just who might be dumb enough to buy these shares. Guessing Warburg Pincus does not count.
February 8, 2008 at 12:24 am
One thing I didn’t see mentioned was that no country wants a strong currency and they have the means to carry this policy out.
I think the key new currency is gold. It is now moving higher to new all times highs against all currencies.
I believe that is the definition of a bull market.
February 8, 2008 at 11:41 am
cwd, I’m not aware of any civilized country where gold is accepted as a currency.
I also think that any strong currency must inflate 1%-2% per year just to prevent the disastrous fallout into deflation. Gold doesn’t have this useful feature, if it inflates for some time it will necessary deflate as well, which is completely unacceptable.
And third. If you plot any reasonable asset against dollar and against gold you will see that dollar is much more stable than gold. You don’t want to have a currency that fluctuates like gold does, it will be a disaster.
February 8, 2008 at 6:45 pm
Another crack in the Wall:
us.ft.com/ftgateway/superpage.ft?news_id=fto020720081434387218&page=1
Western banks face backlash as they hand out begging bowl
Earlier this week, I chatted with a jet-lagged senior US financier. Like many of his ilk, he is flitting around the Middle East and Asia trying to extract finance from sovereign wealth funds and other investment groups.
His latest travels have delivered a surprise: some funds are quietly getting cold feet about the idea of putting more capital directly into western banks, he says.
“There is a backlash building,” he muttered into a crackling cell phone.
But having stepped into the breach so visibly late last year, some funds are now getting jitters. In China, for example, there are rising complaints that funds are foolish to shovel cash directly into risk-laden US banks when they could be using it in better ways, such as purchasing western commodity or manufacturing groups.
February 9, 2008 at 10:15 pm
Ryan, you can e-mail me at my name at the google mail. But I check that mail only once in a while, don’t expect fast reply.
April 30, 2008 at 12:30 pm
[…] oil prices because taxes on fuel are so high. Until recently, we’ve also been protected by the falling dollar. But prices are still rising – and petrol is at 104.9p a litre in London as I write […]