February 20, 2004

A Reprieve for Dollar Bulls

Well, this is one way to keep the yen weak without intervening in currency markets. "Japan intensified security at airports, nuclear plants and government facilities today as a precaution against a possible terror attack. The government's heightened alert sent a shiver through global financial markets, knocking the Japanese yen to ten week lows against the dollar. The National Police Agency refused to discuss whether the government had new information about a possible terror strike."

Ultimate Consequences

One way to describe the willingness of Asian countries to buy U.S. bonds and keep their currencies weak is to call it for what it is: vendor financing. Loaning money to your customers so they can afford to buy your products is a risky proposition, however. So is keeping your currency cheap in order to make your exports competitive, so Americans can buy them on debt. Sooner or later, you either lend more money to your cash-strapped customer, or he stops buying because he's got not resources himself. As a vendor, the sooner you realize this, the sooner you'll stop lending. From this article it looks like the Japanese are beginning to realize that selling to Americans on credit has its own kind of economic blowback. "...counting on the seemingly insatiable appetite of the American customer, the allocation of economic resources in the Japanese and other Asian economies appears to have been distorted to a larger extent than before. "In this trans-Pacific macroeconomic picture, Japan and the other Asian nations appear to be behaving like innocent merchants willing to sell on credit as much as their customers want. This framework has persisted for the past three decades or so, ever since the United States began to float the dollar in the currency market. "Sensible persons even without business expertise know the ultimate consequences of such relations between merchants and customers. " Indeed they do. Bankruptcy for the customer, non-performing loans for the vendor. Wasted capital for everyone.

Chart of the Day: Semis Turning

Below a three-year chart of the semiconductor holders (SMH), weekly closes, with a 25-week moving average. The index is either getting ready to move up and out of its current range and crack through 45, or violate the strong uptrend since March of last year. The moving average is flat.

February 19, 2004

Reader Mail

I agree with your comments about the future of an unbacked dollar and am also very bearish on bonds and the dollar in the long term. All you have to do is look to the south to Latin America to see what happens to the currencies of governments which print up money to pay their bills. Anyone who kept his wealth is Brazilian or Argentine local currency bonds lost all of his money when the cruzeiro/cruzado and peso/austral went to zero. That is our future, I am afraid, and I will guarantee you that wealthy Brazilians and Argentines don't keep their money in local currency bonds. Gold bullion (preferably offshore) is my preferred investment for the "have money" portion of my portfolio as opposes to the "make money" portion.

Quote of the Day: Apocaholism, or Just Reality?

If your friends are looking at you like you have a third eye because you happen to think the world's financial system is undergoing some serious stress, don't worry. You're in good company. That doesn't mean you're addicted to bad news, or even hope that it happens. I certainly wish for a stronger dollar now that my cost basis is euros. But what a weak dollar has forced me to do is scale back how I spend money. Not that I was lavish before. But Paris is expensive, and a weak dollar doesn't help. I believe I'm on the leading edge of a storm where everyone's dollars lose purchasing power, not just expatriates like me here in Europe. It's going to be a radical adjustment for people--especially if they've spent too much or borrowed too much. True, inflation helps out debtors. But if it also means your cost of living goes up much faster than your income, it's not benign at all. From Stephen Roach: Central Banking Discredited "They are yesterday’s heroes. Central banks ruled the world during some 22 years of disinflation. But like most champions, they have overstayed their welcome. The world’s major central banks — the Federal Reserve, the Bank of Japan, and the European Central Bank — have squandered the capital they built up in the long and arduous war against inflation. And now, with their policy arsenals dangerously depleted, they are woefully ill-equipped to cope with the ever-daunting complexities of a post-inflation era. Bondholders beware: Your once-proud defenders have met their match. I fear modern-day central banking is on the brink of systemic failure."

Chart of the Day: OEX Walking the Plank

Blogging has been light to day as I put the finishing touches on the March dead tree issue of Strategic Investment. I'll be modest and say I think it's a good one. We live at the confluence of some major financial and historical trends, which makes investing pretty difficult. But if we're at the junction of several "super cycles" (i.e. debt), as least we have "Boyd Cycles" working for us. That is, most wave theories (Kondratiev and Elliott are two) are great for identifying where you are in the big picture. They are truly "strategic" views of the economy and the market. Tactically--in the place where you have to make investment decisions every day with your money--they're less useful telling what to buy and sell and when to do it. That's where Boyd Cycle's come in. Boyd's OODA loop (observe, orient, decide, and act) helps you every single time you make an investment decision. It's a way of making decisions--not just a way of understanding the market. (For more on Boyd Cycles check out this post from last week. S&P 100 Historically Overbought On to today's chart...courtesy of the good folks at www.stockcharts.com. It's an excellent time with some great tools. The chart below is a measure of breadth. Specifically, it tells you what percentage of stocks on the S&P 500 have bullish point and figure charting formations. I'm not an expert on point and figure charting--although my friends Lynn Carpenter and Katie Kropkowski use it frequently. But what the OEX Bullish Percentage chart tells us is how many stocks on the S&P 100 are in bullish patterns. I pick the OEX, as you'll recall, because it's the highest concentration of tech and financial stocks of the major indexes, with over 27 tech and financials making up over 40% of OEX's $2.7 trillion market cap. You'll notice that any time the bullish % on OEX goes over 70, a correction ensues, whereas 30 looks like the level where it gets oversold. Right now, it's executing a walking-the-plank formation. Actually, there's no such technical term I know of. But it does convey my point: the OEX is overbought and trading on borrowed time. Update: Notice too, that the lows keep getting lower, until early 2003, right before the current rally. Since then, even after being overbought, the corrections have been less severe. OR, the next big correction may make a new multi-year low. Walking the Plank Formation

$384 Billion to Go...Before Congress Changes the Rules

Wrote the story below up in my notes for the Daily Reckoning the morning. The government is near its self-imposed (an routinely self-violated) spending limit. Bond prices are virtually unchanged, but edging slightly up--as measured by TLT, IEF, and LQD. The dollar was its strongest in six days early today. But its sliding a little as I write. Who knows what currency traders are thinking? Or what positions they have at dollar/euro 1.30? As I said this morning, the ECB has signaled loud and clear, through Issing's essay in the Journal, that it believes the Fed has facilitated a financial asset bubble with low rates...and that it won't make the same mistake, even, and here's the implication, if it means the euro crashing through 1.30. Traders don't believe that yet, or don't want to think about a world with the dollar in free fall. If you haven't thought about it, it's not too late. Since bond prices don't seem to be busting any lower on dollar weakness, the best way to be short the dollar is to be long gold, and let the the complex relationship between the dollar and the bond market work itself out. Speculators have more choices, on which I'll have more to say later this week or early next. I'm sure our children will thank us for this. "WASHINGTON (Reuters) - The U.S. government's national debt -- the accumulation of past budget shortfalls -- totaled more than $7 trillion for the first time as of Tuesday, according to a Treasury Department report. "In its daily financial statement released on Wednesday, the Treasury said the U.S. debt subject to a congressionally set limit totaled $7.015 trillion, up from $6.983 trillion on Friday. The government was closed on Monday for the Presidents Day holiday. "While passing the $7 trillion mark itself has little practical significance, not unlike a car's odometer rolling over, it may signal some tough political times for President Bush's administration on fiscal policy. "The government debt ceiling stands only a few hundred billion dollars ahead at $7.384 trillion, and Treasury would need Congress's blessing to borrow beyond that. Treasury officials say they expect the limit to be hit sometime between June and October. "

February 18, 2004

Overbuilding, Underbuying

The Commerce Department reports that January housing starts were down nearly 8% from December's record. Meanwhile, the Mortgage Bankers Association reports that its purchase index, a measure of new loan requests, was up 2.9%. And finally, the National Homebuilders Association reports that its Housing Index, a measure of sentiment in homebuilders, fell from 69 to 65. At the very least, it seems like housing activity--both building and buying--are coming off record levels. But one month does not a bust make. Still, you're starting to see signs that interest rate sensitive demand might be slowing while home building supply keeps increasing. As Scott Winningham, an economist at Stone and McCarthy Research Associates said in a Reuters article, "There's a growing divergence between new home sales, and homes being started and those still on the market." The Fed doesn't figure to raise rates anytime soon. So you may well see mortgage rates remain relatively low, even historically low. Then we'll just have to see if the low-rates continue to attract new buyers. Demand is a function of affordability. And with incomes already under pressure (see Faber charts below), will 2 million new buyers a year keep stepping up to the plate to buy their first home?

Synesthesia: Letters as Colors, Shapes as Tastes-- Without the Acid

This is strictly brain candy, but fascinating. "In his earlier research, Cytowic documented a number of startling cases, including such well-known figures as Russian novelist Valdimir Nabokov, who as a child complained to his mother that the colors of the letters on his wooden alphabet blocks were all wrong. She knew, because she also saw letters as colors, and they clearly were not the same as those on the blocks. "The condition, which is genetically transmitted, seems especially prevalent among highly talented and gifted persons. The Russian composer Alexander Scriabin, who saw sounds as colors, even composed a symphony in 1910 that featured a colored light exhibit that he, no doubt, could see even without the lights. Other synesthetes, as they call themselves, include the poets Baudelaire and Rimbaud, painters Kandinsky and Klee, and the noted physicist Richard Feynman. "No one knows just how many people have the condition. Estimates range from one person out of every 300, to one out of every few thousand. The number is vague for obvious reasons. Some people learned early on not to talk about it out of fear of being regarded as odd. And those who have it tend to like it, so they don't feel a need to seek out medical help."

Charts for the Day

The balance sheet of ordinary Americans is in bad shape. Below are charts from the February issue (Dr. Faber's article) showing just how bad. I republish them for the benefit of some Daily Reckoning subscribers, whome we will have as guests to the Insider for a few days.

The Goods on Government Debt

Two weeks ago, I blogged up a storm on debt and deficits. You may remember the stupefying details. However, with the deft editing of David Galland at Casey Research, my comments were turned into a spirited debate with Gary Alexander about the nature and consequences of government debt and deficit spending. If you want to see the whole thing, go to http://server.publishers-mgmt.com/wwnk/doc/20040216.php . In my opinion, here's the money quote: "The real cost of the debt is not measured in terms of its percentage of GDP, whether you're talking about annual deficits or the cumulative public debt. The real cost is that government borrowing slows down economic growth over the long term, to say nothing of what it does to the vitality of citizens who grow dependent on government largesse."

February 17, 2004


As I wrap up from Paris tonight, gold is up $5, the dollar is trading near all-time lows against the euro, bond yields are flat, and stocks are up. The Fed told us that foreigners snapped up $75.7 billion in U.S. stocks and bonds in December, less than November, but still net buying, not selling. I told Strategic Options Alert subscribers today that it won't make sense, it won't be based on values, and it will be deadly for a lot of investors...but we could see a lot of liquidity move into stocks in the next few months. How much? I think enough to push the market to a new high. I note that financials, as measured by the banking index (BKX), broker/dealers (XBD), and S&P financials (XLF) are all at new all-time highs. That's right. They've recouped their bear market losses and made new highs. Small caps could be next. A few weeks ago I thought this was improbable, based on the action in the S&P 100. But at the margins, in the most speculative shares, we're seeing signs that it COULD happen. If it does, it's a pure speculators's play. Institutions can't afford to be on the sidelines. And individual investors will find it very hard to resist. I suggest you do, though, unless it's play money. Keep accumulating gold shares. As I'll explain tomorrow, I think they'll do well even in a non-inflationary scenario. The posting was pretty heavy today. But it's issue week for me (meaning I'm putting together the March paper issue of SI.) So I've got a lot of material on my desk that I wanted to pass along. Now, I'm passing along to dinner. G'night from the right bank, Dan

Who's the Fourth Largest Owner of U.S. Bonds?

Here's a fact: between 2002 and 2003, Caribbean banking center's added to their ownership of U.S. bonds by almost 40%, from $49.5 billion in 2002 to $69.5 billion in 2003. They are now the fourth largest owner of U.S. bonds, behind Japan, China, and the U.K. You can see how, with just a little imagination, you could come up with some intriguing explanations for this. Narco traffickers, terrorists..Hungarian born international financiers building a huge position up...to gain some leverage. Some political leverage. Or it could just be hedge funds. I'm checking with my friend John Mauldin, the hedge fund guru, about this. And aside from the cloak and dagger, it seems like a new kind of issue in international capital flows...non-state actors establishing huge positions in U.S. bonds. If it's just an aggregate number--a few hundred or thousand wealthy individual investors holding U.S. bonds through off-shore banks--it's much less...ominous. Curiously, the Fed doesn't seem to know much about. Hat tip to the fire-breathing Doug Noland at Prudentbear.com for unearthing this exchange last week between a man who knows a thing or two about capital flows--former Goldman Sachs co-chairman and current senator Jon Corzine--and Alan Greenspan. Here's the exchange with commentary from Doug. Emphasis added is mine. "It is fascinating to have the former Goldman Sachs co-chairman posing questions to our Fed chairman. I found the following discussion, and Dr. Greenspan's apparent impatient demeanor, especially intriguing. Senator Jon Corzine: "With regard to top 10 countries holding our national debt. I have a particular curiosity about the Caribbean banking centers and what their implications are with respect to our concern about funding of all kinds of miscellaneous problems that could potentially exist. And I would love to hear an analysis of what is driving the fourth-highest concentration of our debt being held by Caribbean banking centers." Alan Greenspan: "I'm sorry, was that a question to me?" Senator Corzine: "Yes, that is a question that we can ask if there could be an analysis that..." Alan Greenspan: "One has to look at it." Senator Corzine: "Yes, please." Alan Greenspan: "And in the context of, as you are far more aware than I, that the amount of information that those individual institutions in those various areas produce is less than we would like to see. But we'll take a look at it and see what we can find." Senator Corzine: "I think the issue in the funding of global terror, one wonders why so much of the external debt the United States is getting housed in among institutions that we have very little idea about. I think it's a fair..." Alan Greenspan: "We'll see what we can find." Noland comment: It is Simply Not Credible that the Fed has not by now spent significant resources delving into the issue of ballooning holdings of U.S. securities at off-shore banking centers.

Bait and Switch

Everyone seems to think the outsourcing phenomenon mainly benefits U.S. corporations first, in the form of lower labor costs, and foreign wage earners in the second, in the form of higher relative wages. But it may turn out to benefit shareholders of domestic-listed shares in countries where the outsourcing is done. At least that's what the quote below from this article suggests. Here are the key graphs: "At present it is spoken of in hushed tones, but it's a reality. US companies, especially if the founders are of an Indian origin, are definitely thinking of a flip, where the subsidiary in India becomes the parent company and the erstwhile US parent company becomes its subsidiary. This is done through a swap of shares. The newly-formed Indian parent company then proceeds to get listed in India. "Service companies command better valuation in India compared to the US. Also cost for listing in the US is comparatively high and regulations more stringent. Thus, many US-based service companies having development centres in India are looking at an Indian listing that is achieved through a flip," said Shefali Goradia, head (international tax practice), Nishith Desai Associates. "A couple of IT-enabled services (ITES) companies, where the parent was set up in Silicon Valley with subsidiaries in southern India, are in the final stages of discussions with their consultants on adopting this model." I counted 31 Indian shares trading on major international exchanges. I've listed them below but haven't begun to dig into them for specific recos. That's next. For now, anything with a three our four letter symbol trades on the American market either NYSE and AMEX (3 letters) or Nasdaq National Market (four letters). There are ten U.S. listings. Anything more than that is an issue that trades over the counter, either on the Nasdaq bulletin board or overseas. They are: Arvind Mills Ltd. (AVRNF) Dr. Reddys Labs (RDY) Gail India Ltd. (GAILY) Grasim Industries Ltd. (GRSJY) Gujarat Ambuja Cements Ltd (GUJRY) HDFC Bank (HDB) Icici Bank Ltd (IBN) Indian Petrochemicals Ltd. (IDNCY) Indian Rayon and Industries (INRXY) Indo Rama Synthetics (IDRMY) ITC Limited (ITCTY) Infosys (INFY) JCT Ltd. (JCCTY) JK Corp. Ltd. (JKCXY) Larsen and Tourbo (LTORY) Mahanagar Telephone Nigam (MTE) Ranbaxy Laboratories Ltd (RBXLY) Rediff.com (REDF) Reliance Inds Ltd (RLNIY) Satyam Computer Services (SAY) Sify Ltd (SIFY) Silverline Technologies (SLTTY) Southern Petrochemical Inds (SXPCY) Ssi Ltd (SSXGY) State Bank of India (SBKIY) Sterling Biotech Ltd. (STLGFM) Tata Motors Ltd. (TENKY) Tata Tea Ltd (TTAEY) Videocon Intl Ltd (VDOIY) Videsh Sanchar Nigam Ltd (VSL) Wipro Lts. (WIT)

Gold and Price Stability

If you want to know how exceptional the current monetary regime of the dollar standard is, check out the excerpt below from a study by the Office of National Statistics in the U.K. Money stat: for 188 years, prices rose a little over three times. Since 1938 (with the help of FDR and Nixon) they've risen more than forty times. "If there had been decimal currency 250 years ago, a penny then would have bought more than a pound does today, according to a new long-run price index which tracks the path of consumer price inflation since 1750. It shows that between 1750 and 2003, consumer prices rose about 140- fold. "Most of the increase over the period has occurred since the start of the Second World War: between 1750 and 1938 prices rose by a little over three times, but since 1938 more than fortyfold. However, in the earlier period inflation was not constant: prices roughly doubled between 1750 and the end of the 18th century, but were at about the same level over 100 years later, prior to the start of the First World War. The fluctuations during this period partly reflect harvest quality and wars, with a 50 per cent increase in prices over the first ten years of the Napoleonic Wars. "The First World War also had a significant effect on prices, with prices more than doubling during the war and the two succeeding years. But in the period 1921-1934, prices fell in most years, or at most showed very small increases, reflecting the falls in profits and wage costs associated with the Depression. Prices have risen in every year since, with particularly rapid price increases between 1973 and 1981, when prices more than tripled and the inflation rate exceeded 10 per cent in each year except 1978. "This was a time when all the industrialised world was struck by a series of supply shocks, including a quadrupling in the world price of crude oil in 1973." You'll note that 1973 was also time, not coincidentally, that Nixon took the U.S. off the gold standard and launched this modern experiement in floating exchange rates with currencies backed by nothing but current perception of future growth prospects.

High Yield AND Capital Gains: Chart of the Day

The Reserve Bank of Australia calls its benchmark interest rate of 5.25% "accomodative." Oh my goodness. But they also suggest room to raise rates if the Australian economy overheats. The range suggested by a bank official is between 5.25 and 6.25. Quick, get some Aussie bonds! While the U.S. Fed is slouching towards monetary purgatory, central banks in Australia and England are offering global investors yields that make it easy to get out of the dollar. And if your cost basis is dollars, the Everbank World Currency CDs I mentioned in the Housing Report are a great way to get yield and benefit from any continued gains in the currency of your choice. I recommended the Aussie currency CD because of the hawkishness of Australia's central bank. (If you want to know more about this, send me an e-mail at strategicinvestment@agora-inc.com with "Everbank" in the subject line.) The chart below shows the gain in the Australian dollar over the last year, via the Philly listed Australian Dollar Index (XAD). It also shows the performance of the Australian iShare (EWA). Speaking of which, the composition of the iShare is significantly financial (30% banks). But it's also 20% basic materials...which by the way is a PERFECT way to play commodity prices and the Asian stories...capital intensive basic materials industry on a continent within shipping distance of Asia's resource ravenous economies. A LOT MORE on this in the March issue and later this week. Australian Stocks and Currency Powering Up

Here Comes the Wage Gap Issue

Election issue watch: outsourcing. Greenspan and the Chairman of the White House Council of Economic Advisers don't believe outsourcing is an economic problem. It may be a political one, though. First, economically, it's not clear yet what the long-term impact of outsourcing will be. Short term, according to a Bloomberg article, "Over the next 15 years, 3.3 million U.S. service-industry jobs and $136 billion in annual wages will move to India, the Philippines, China and Malaysia, among other countries, according to a study by Forrester Research Inc., a Cambridge, Massachusetts, consulting company." That's 3.3 million in addition to whatever manufacturing jobs are displaced. Of course an economy is always gaining and losing jobs. Ideally, jobs are created in those industries an economy has a comparative advantage in. For example, as computing and technology become more pervasive, you'd expect more jobs in new technology related-fields or in other parts of the economy that use technology in new ways. This is sort of a second-generation, more sober "new economy idea that recognizes today's technology is just a tool, not and end. However, despite the promises of bio-tech, nano tech, silicon chips, etc...we simply haven't seen this yet. Yet. Will we? I don't' know. In the short-term, to those who've lost their jobs (and have a vote) the loss of jobs looks more like a major decline in living standards of living than the sign of a "dynamic economy." Not so, said the Chairman of the Federal Reserve in his testimony to the Senate last week, "What will ultimately determine standard of living of this country is the skill of the people.'' Workers, after all, aren't machines. A human being can't be made obsolete because he loses his job. He may have to train for a new job and adjust. But that happens all the time in an economy. And in truly competitive economies, workers adjust and gravitate toward the higher wage jobs. That's the theory, anyway. In reality, the missing component to the theory is the lack of new job creation in the United States. Maybe it's coming. Maybe we really are on the cusp of robust, tech-driven, work-force transforming boom. We simply don't know. This a new development in global trade, where jobs become a commodity and move across borders as easily as lumber, pomegranates, or scrap metal. If labor is commodified (employers get the most skill at the cheapest cost because of a competitive labor market), it should lead to generally lower prices, which you'd think would be good for consumers. But even if the world were approaching a golden age of a price stability, you'd have the problem of income instability. As the job market gets shuffled, a lot of workers get "displaced." And until the new job-producing industries make themselves known, you're going to find an awful lot of disaffected, displaced workers/voters. They won't have time for the subtleties of macro-economic labor market theory, and unproven theory at that. But they WILL understand the emotional logic of a growing "wage gap." And they'll want it closed. With tariffs. My guess, Kerry introduces the idea of tariffs into his campaign, or simply names Dick Gephardt as his running mate. At a debate sponsored by Pace University in September of last year, Gephardt said, "We need to have a policy to build new jobs in this country. Part of it is fair trade, not just free trade. Most everybody here voted for NAFTA, voted for the China agreement. I did not. I led the fight against it. That's the kind of trade policy we need that globalizes with fairness and standards around the world so work, wherever it's performed, is given a fair wage for their hard work." First, it looks like a throw away line, but a "policy to build new jobs." Hmm, how about the free market? Second, what is "fair trade?" I'm guessing the kind that doesn't cost American jobs but provides cheap goods. But I'm sure we'll find out soon.

February 16, 2004

Wastepaper, Quote of the Day

Tom Donlan gets it right in is commentary in Barron's this week. You might think that with the big fat greenback making the cover of the Economist and everyone and his dog going bearish on the dollar, the truly contrarian play is to be a dollar bull. Sentiment is so universally negative that this must be an extreme, right? Well, sentiment is negative, but the money managers and traders I had dinner with in London last week said now one is actually making the bearish trades. Everyone is convinced the dollar is going down. But very few traders are actually "selling it." This tells me there's a rational understanding that the twin deficits make the dollar a weak proposition. But emotionally, no one is ready to contemplate life with dollar/euro at $1.50 and dollar British pound at 2/1. It reminds me of an old golden retriever I had. His hips were going. He couldn't run. He'd routinely fall down stairs. It was obvious his best days were behind him and that he'd have to be put down eventually. But all I could see when I looked at him was the dog that used to spend all day chasing tennis balls and digging for rocks. What the currency markets need is some emotional closure. "You don't have to wish for gold coins clinking in your pocket to realize that gold is still a relevant measure of wealth, no matter how many economists denounce it as a barbarous relic. Without some attachment to harder values, the half-life of paper money is Hobbesian -- "nasty, brutish and short." "Fortunately, the U.S. is not merely on the Greenspan standard. Confidence in the chairman of the Federal Reserve is trending lower with the dollar, and deservedly so. Interest rates would be substantially higher than they are if Greenspan had not been part of the two-year soft-dollar policy. "In reality, however, the U.S. is on the gold standard, the crude-oil standard, the copper standard, the commodity-index standard, the stock-market standard, the bond standard and the interlocking standard of all currency markets. Every day, millions of traders, speculators and investors pass judgment on the dollar and its stewards as much as on the supply and demand for whatever they happen to be buying or selling that's priced in dollars, euros, yen, yuan, rupees or wastepaper. When the dollar goes down, that's a sign we're going wrong. "As any Argentine must know by now, the markets, like the mills of the gods of old, grind slow, but they grind exceedingly fine. At the moment, the markets threaten to grind the dollar to powder.