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XMFSinchiruna (27.75)

Anybody wondering where this dollar strength is coming from?

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August 26, 2008 – Comments (16)

As I mentioned in previous posts, there has been a concerted effort by the ECB to shoot itself in the foot by buying up USD very suddenly to create this mini-rally in the greenback. What I didn't realize was that China was playing a big role behind the scenes all the while. This is interesting stuff, but again does not signal a fundamental return to strength in the American currency, but rather a sacrificial move by central banks to acquire weak dollars to prevent a breach of that key technical impasse at 72 for the USDX. A reach of 72 on the USDX would have made 62 the next technical target, and worldwide dollar selling would have accelerated substantially. The mark will be defended again when the dollar resumes its inevitable slide, and they might even succeed in creating another meaningless mini-rally, but ultimately these types of intervention cannot be upheld since they represent a dangerous disconnect from the actual value of the currency. A market where buyers buy because they fear the consequences of not doing so is not a healthy market. I sure hope no Fools are long the USD here.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/26/ccchina126.xml

Beijing swells dollar reserves through stealth
Last Updated: 12:31am BST 26/08/2008

Rule changes for commercial banks are acting as cover for exchange rate intervention, writes Ambrose Evans-Pritchard

China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy.

A study by HSBC's currency team in Asia has concluded that China's central bank is in effect forcing commercial banks to build up large dollar reserves, using them as arms-length proxies in a renewed campaign of exchange rate intervention.

Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.

This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March.

"China has used the pretext of reserve requirement hikes to help slow yuan appreciation. We estimate that the PBOC [central bank] intervened by about $49.6bn in June," said Daniel Hui, the bank's Asia strategist.

Beijing has also slashed the amount of foreign debt banks operating in China can hold. The effect is to oblige the banks to become net buyers of dollars, halting the flow of foreign "hot money".

Given the sheer scale of China's foreign reserves - now $1,800bn (£970bn) - any shift in its exchange policy now ripples around the globe. The covert buying may help to explain at least part of the explosive dollar rebound over recent weeks.

There is little doubt that the key driver behind the wild currency ructions this summer has been the blizzard of dire data from Britain, Europe, Japan and Australasia. The mounting danger of a full-fledged recession across the club of rich OECD nations appears to have caught the markets off guard.

The closely watched Dollar Index reached an all-time low in March. It crept up gradually in the early summer before smashing through resistance in July.

The world's currency system is swivelling on its axis. Central banks in Asia and Europe have stopped raising rates, and some have begun to cut aggressively. The Federal Reserve is no longer nakedly exposed. Indeed, investors are already starting to look ahead to the next round of Fed tightening.

The 18pc slide in oil prices from a peak of $147 a barrel in July has added juice to the dollar rally. Russia and the Middle East petro-powers tend to recycle a high proportion of their vast earnings from oil into the eurozone, either by purchasing European bonds or expensive imports.

A Bundesbank study found 40 cents of every dollar spent by eurozone countries on oil imports comes back again one way or another. The figure for the US is just 10 cents. This trade bias has given oil a new character as a sort of anti-dollar driving the currency markets.

Even so, the China effect is a key ingredient in the dollar comeback. Beijing's Politburo is clearly disturbed by the sudden downward turn in the economy as export markets freeze, and surging wage inflation in the country's manufacturing hubs eats away at profit margins.

"They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view," said Simon Derrick, exchange rate chief at the Bank of New York Mellon.

China's PMI purchasing managers index fell below 50 for the first time in July, signalling an outright contraction in manufacturing output. Hong Kong's economy contracted 1.4pc in the second quarter. The Politburo has rushed through special rebates for textile producers now caught in a ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

"During the first half of this year, about 67,000 small and medium-sized companies went bankrupt throughout China, leaving more than 20m people out of work," said the National Development and Reform Commission. "Bankruptcies of textile and spinning companies have numbered more than 10,000. Two thirds are on the brink of bankruptcy."

Last week's rebound on the Shanghai stock market stalled on fading hopes of a fiscal stimulus package. "It is unrealistic to expect the government to rescue the market," said Li Ka-shing, chairman of Hutchison. "Speculators should be very cautious now. The worst is not over in the global credit crisis."

Lehman Brothers warns of a risk that a housing slump and the 55pc equity crash since October could combine with a global downturn to set off a "vicious cycle". House prices have already fallen 18pc in Guangzhou and 9pc in Beijing. Prices are now falling in cities that make up over half China's population.

 

 

16 Comments – Post Your Own

#1) On August 26, 2008 at 11:45 AM, rofgile (99.31) wrote:

So, my picture of the world is that banks lended too much for people to buy houses at a time when rates were low and things looked great for the future.  At the same time, the people being lended to were starting to reach their spending and not saving limits.  The result is that the bank loans were not good, and now people cannot get new loans as easily. 

 So, with a lowering amount of good loans and money available, does this equal deflation?  And if so, could the dollar gain in value simply because it is getting more scarce?  If the dollar is gaining in value, wouldn't it make sense for Chinese banks to invest in the dollar and trade out of the currency later on?

 I still believe that we are going into inflation because of our huge debts and needing to print our way out of problems in the US.  However, I am worried about investing too much on this idea of inflation as I am somewhat new to investing still. 

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#2) On August 26, 2008 at 12:04 PM, daayoo (< 20) wrote:

You pretty much got it. Less dollars and tougher loan standards equal deflation. Also the dollar's buying power willl go up because the greenback is bieng sucked out of the market.

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#3) On August 26, 2008 at 1:38 PM, XMFSinchiruna (27.75) wrote:

rofgile

The dollar is not getting more scarce... the printing presses are running non-stop trying to inject enough liquidity to prop the credit markets up... this is inflationary.

daayoo

M3 is continuing to expand. What exactly is sucking USD out of the market??? On what basis do you make the determination that the buying power of the greenback will rise?? I don't want to rehash the entire debate of inflation v. deflation which has been hashed out in these blogs ad nauseum, but I want people to be clear that nothing that is happening today is indicative of future strength in the USD.. nothing!

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#4) On August 26, 2008 at 1:47 PM, XMFSinchiruna (27.75) wrote:

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#5) On August 26, 2008 at 2:32 PM, rofgile (99.31) wrote:

TMFSinch, if you had a tougher time getting a loan for a house or a small business startup, it is as if you have less money to purchase the house or small business. 

If you have a whole country of people with the same problem, there will be much fewer buyers for what assets there are.

The price of the assets will have to fall.

To me, it seems possible that there is less money available (even with printing presses running constantly).  This is because while we are increasing the amount of dollars that exist in the world, the amount that is accessible for buying/selling goods for the majority of people is decreasing.  What does it matter if M3 increases if I can't get a loan or my wages don't increase?  This is my question for you.

 (I am not trying to shoot you down, I am currently invested in silver, so I am guessing that we will have inflation.) However, I am sincerely worried that I am misunderstanding inflation and that we are heading to deflation.  I am also worried that it is banks that are having the most problems, and deflation normally helps banks.  Could they purposely drive us to deflation by over restricting loans for a while?

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#6) On August 26, 2008 at 2:37 PM, rofgile (99.31) wrote:

TMFSinch, if you had a tougher time getting a loan for a house or a small business startup, it is as if you have less money to purchase the house or small business. 

If you have a whole country of people with the same problem, there will be much fewer buyers for what assets there are.

The price of the assets will have to fall.

To me, it seems possible that there is less money available (even with printing presses running constantly).  This is because while we are increasing the amount of dollars that exist in the world, the amount that is accessible for buying/selling goods for the majority of people is decreasing.  What does it matter if M3 increases if I can't get a loan or my wages don't increase?  This is my question for you.

 (I am not trying to shoot you down, I am currently invested in silver, so I am guessing that we will have inflation.) However, I am sincerely worried that I am misunderstanding inflation and that we are heading to deflation.  I am also worried that it is banks that are having the most problems, and deflation normally helps banks.  Could they purposely drive us to deflation by over restricting loans for a while?

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#7) On August 26, 2008 at 3:34 PM, XMFSinchiruna (27.75) wrote:

rofgile

The banks are over-restricting loans right now because they are essentially insolvent. They are in no position of power to be driving the economy in one direction or another. Yes, asset prices will fall, and sharply. Yes, consumers will have less access to the dollars that are in circulation because of falling wages, lost credit availability, etc., but we are concerned with the global supply of USD.. the M3... since it is after all a global market that determines the value of the greenback.

 

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#8) On August 26, 2008 at 3:42 PM, GeneralDemon (20.66) wrote:

Wow, rofgile:

(I am not trying to shoot you down, I am currently invested in silver, so I am guessing that we will have inflation.) However, I am sincerely worried that I am misunderstanding inflation and that we are heading to deflation.  I am also worried that it is banks that are having the most problems, and deflation normally helps banks.  Could they purposely drive us to deflation by over restricting loans for a while?

You speak the truth!! You "get it". For some reason, most people are not getting it. There is a gigantic struggle going on right now between the forces of Inflation and Deflation. You probably should hedge your bets. Very smart people are on both sides of the issue. But I do have some advice for you: don't trust people who claim that " the printing presses are running non-stop" because they don't know how money is created. If you ask them to explain how "the printing presses are running non stop" at the same time as mean wages are stagnant and all asset values are dropping, you may find that they have a much weaker argument. 

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#9) On August 26, 2008 at 4:42 PM, XMFSinchiruna (27.75) wrote:

GeneralDemon

Wow General... feel free to address me directly on my own blog.  :)

Do 100s of billions in 'special' facilities at the Fed windows ring a bell? $160 billion in 'stimulus'. How about the implied backing of Fannie and Freddie by the U.S. Treasury... I suppose they had plenty of USD lying around in vaults somewhere to cover that debacle. The loss of wages and declining home values PALE in comparison to the immense systemic failure of the derivatives markets, the implied guarantee of huge financial institutions (not just Freddie and Fannie), the re-funding of FDIC and SPIC that will have to take place following future bank and brokerage failures,etc.... all aimed at preventing the unthinkable... the firesale of USD assets by foreign central banks no longer willing to watch their investments suffer further losses. 

I understand precisely how money is created, thank you. I understand that every day we're spending $720 million to fund the unwarranted war in Iraq,and that these sums being plundered are orders of magnitude beyond what revenue the government is collecting from the citizenry, requiring the creation of promisary notes (treasury bonds) funded in their great majority by foreign central banks in order to purchase dollars from the Federal Reserve for a fee... even though Article 1 of the Constitution of the United States declares that only the U.S. Congress shall have authority to coin money and regulate the value thereof.

I know that the only true measure of total U.S. currency in circulation was abruptly cancelled from publication for the first time in its history the moment it began to really accelerate to unprecedented levels. I know that inflation figures as represented by the CPI and other 'official' measures have no basis in reality whatsoever, and that price inflation continues to rise despite a concerted effort by some very powerful entities to drive commodities like oil down just as the dollar was driven up.

I know my history, too. I've studied the Great Depression in depth, the very instructive example of the Weimar Republic, and the hyperinflation of the late 1970s (laughably minor compared to where this event is headed).You absolutely, most assuredly CAN have simultaneous asset devaluation and wage declines in the midst of runaway inflation. It has happened before... and it's happening again.

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#10) On August 26, 2008 at 6:49 PM, GeneralDemon (20.66) wrote:

Since you studied the depression in depth, then you will know that during the hyper-inflation of the Weimar Republic, employment was at maximum! So many people were employed that productivity plunged.

How about the classical relationship between wage inflation to total inflation (typically 80%). If wages don't follow, then you still see sustainable inflation coming?

Aren't most of your examples of Fed window facilities just replacements of lost bank capital? For every new dollar those banks get from the fed, they have to loan out 11 dollars just to get back that lost dollar. And, since borrowing rates are plunging, where are the added dollars???

You're right-on about the war. It scares me to think they might need a bigger one in the future to wash out this mess.  

It seems like the chickens have to come home to roost sometime - the people of US, Eurozone, India and China are getting asset poorer day by day. You don't worry about demand destruction? 

By the way, sorry for the slight - I always like reading your blogs and admire your insight. 

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#11) On August 26, 2008 at 8:05 PM, oldfashionedway (35.39) wrote:

With apologies to Ross Perot-

That sucking sound you hear is trillions of US$ going to foreign investors and governments.

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#12) On August 26, 2008 at 8:37 PM, XMFSinchiruna (27.75) wrote:

GeneralDemon

I certainly do worry about demand destruction, which is why I keep a very close eye on the BRIC economies. If we were to see signs of real trouble in China, then I would reverse my recommendations on most industrial commodities. So far so good with China ... their GDP grew at 10.4% in the 1st half of 2008 and their demand for refined oil products rose 13.9%.

Whether we have 99% employment or 50% employment in the U.S.makes no difference to the course for hyperinflation already set by the Fed and Treasury actions, the size of the national debt relative to the increasing likelihood that we will never pay it off. This economy is far more global than what we had in past events that what happens in the U.S. is not necessarily going to determine our fate.

I don't believe in sustainable inflation... I think inflation will spike HARD before eventually ceding to deflation, but I think it could be 4 years or more before we see that peak. The U.S. will be deep in a depression, Europe will like suffer a similar fate, while developing countries will see a gradual decline in the rate of growth as commodity prices do ultimately strain the emerging economies to their breaking points. There are many possible scenarios, IMO, but I view this is a likely one.

As for whether the Fed facilities are just replacing lost bank capital... no. Those derivatives and CDOs were never real monetized assets, but leveraged, notional assets dreamed up by greedy bankers looking to create wealth from nothing.The Fed is taking those worthless instruments as collateral for one of the facilities, and doling out fresh dollars in return for nothing.They are seeking to make the systemic de-leveraging of bank "assets" a gradual process, whereas the natural order of the markets would have it be much more swift. No doubt a similar aim is behind Lehman's announcement today that they will create a company to buy up mortgage assets. We'll see how that works out.

Every intervention has consequences... and they are not generally positive in the long run. These liquidity injections are clearly being footed by taxpayers, as are the wars, the stimulus, the bailouts, the Fannie guarantees, etc. Trillions of dollars in government spending.... it all has to come from somewhere. 

Mark my words, when the Treasury can no longer strong-arm the ECB and China decides to reverse course on its Treasury binge, the Treasury will be purchasing its own bonds with more bonds ... kind of like paying off a student loan with a high-interest credit card. When that day comes, international credibility in the USD as global reserve currency will be gone, and Fools who own gold will be glad they do.

Thanks for the discussion.

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#13) On August 26, 2008 at 9:49 PM, GeneralDemon (20.66) wrote:

I remember my grandfather telling me (as his shoulders slumped in disgust) of when he had to turn over his gold to the government in the 30's.

You seem to think it will get that bad again. I hope not!

But I can't help but feel we will muddle through. The government interventions could also act as adequate dampeners (they get it right by chance despite being blind squirrels).

But, would you give up your gold? Don't think so this time. 

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#14) On August 26, 2008 at 10:00 PM, anchak (99.85) wrote:

Chris...taking on the role of cheerleading these days...eh?

LOL....not a pretty picture you paint, my friend.... I hope this really doesnt come true - but then again hope for the best, prepare for the worst - or something like that!

Its actually the last one -which can be disastrous overall - a medium term runaway infaltion followed by a sustained deflation.

Lets keep our fingers crossed

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#15) On August 27, 2008 at 12:12 AM, MGDG (35.18) wrote:

I was a young struggling 20 something in the 70's and experienced inflationary hard assets, while wages were stagnating. In the late stages the blue collar workers were taking wage cuts, just as Gold was reaching a gain of 2,000%. The companies were cutting wages to deal with the rising cost of the raw materials to manufacture their products.

For Gold to reach the speculative bubble phase of the previous Commodity Bull market, it would have to reach $5,000 oz. I only make this point to show you can have inflating hard assets with stagnating wages. There also were some serious corrections in the price of Gold on it's march from $40 to $850, which shook out all but the most ardent and well capitalized investors along the way.

Fool on--Educate--Make money

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#16) On September 19, 2008 at 2:03 PM, agchris02 (< 20) wrote:

Two things are happening, as noted here:

1)  asset prices are falling (homes, inventories, etc) in the US, at a dramatic rate, in part because banks are illiquid and in part because banks and consumers have been stupid for the past 5-7yrs.  This is not going away anytime soon -- this is deflationary, as noted by others above.

 2) Our wonderful Mr. Paulson and Mr. Bernake (may they collide in a car wreck), have now pledged over $500b (realistically, most reports say a minimum of $1t, closer to $1.5) of tax payer money to buy up the bad debt of banks.  Where is this money coming from?  Asset prices are going down, wages are going down.  Therefore the US will PRINT IT.  E.g. grossly inflationary.  This the exacerbates the problem, as the dollar drops (and it will, you just cant make $1t suddenly appear without the dollar dropping), then the prices of commodities goes higher, quickly.  This leads to lower wages, and lower asset prices again.

 If asset prices (homes) keep falling, as will happen due to the decrease in incomes and real earnings because of inflation, then these bad debts, that the US is going to snap up, now become WORSE debts, worth less.  Well great, lets print more money to cover, resulting in more inflation.......

 THIS IS NOT A CURE...this madness led to Japan losing a decade, to Russia falling off a cliff, to Mexico's currency become worthless.  Why can't we learn?

The mess was created, LET IT CRASH.  It will suck, hell the market might even drop by a historic amount.  BUT IT IS BETTER THAN THE ALTERNATIVE.  The fundamentals of the economy are sound, an unemployment rate of 6% is NOT THAT BAD, especially historically.

The people who can no longer afford their homes aren't becoming homeless, they are just moving into cheaper homes.

Example:

Bob has a $1m house and makes $50K a yr

Jim has a $250K house and makes $25K a yr

Neither can afford their homes, but Bob certain can afford Jim's.  Bob moves into Jim's, and Jim moves into a less valuable home as well (and with home prices dropping, thats even easier).  Which means, only the most expensive assets are left "ownerless."  But they're not truely worthless, rather just grossly overpriced.  That $1m would sell at a lower price.  This is a "finite" disaster, that would overcome as leverage decouples, asset prices decline, and mistakes are corrected.

Devauling the dollar will NEVER end in something good, ever.  This makes me sick.  I get to research all weekend on how to profit from the hyperinflation that will set in over the next 6-9 months.

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