Quote of the Week on Greece's Financial Future; And Thoughts on the Euro and USD

Bloomberg.com is carrying a quote that I believe provides a cogent prediction of Greece's future in Merkel Sets Greek Aid Terms, Sees IMF-EU Tandem as Last Resort. To wit:

“The German strategy for the next couple of months is very simple: provide just enough positive rhetoric that investors continue to purchase Greek bonds,” said Peter Zeihan, an analyst at Stratfor, a geopolitical risk consultancy in Austin, Texas. “On the flip side, they want to make sure via rhetoric that there’s just enough doubt that the markets demand a much higher spread than the Greeks are hoping for. The Germans want to make very sure that the Greeks are punished.”

Sound a bit like World War II at the end. Yawohl?

David Kotok's Cumberland Advisors has been predicting for a few months that the Euro will hold but would show further weakness but would then become a "buy" vs. the U. S. dollar. So far that prediction has been looking - well- prescient.

The idea that the USD would strengthen because little Portugal is downgraded with a governmental deficit of about 9% of GDP, when U. S. deficits are worse, is odd.

The "DXY" tide may be with the USD, but that is a narrow index. The more relevant, broader index of the value of the dollar in the real world is the Trade Weighted Exchange Index. This chart shows essentially a stable dollar lately. The rally in the DXY that may have persuaded some to reprice gold downward is a fake-out. The current financial crisis began in America. The idea that the extend and pretend solution here in the financial community ends with triumph because some small countries in Europe tried to play our game of massive deficit finance without access to their own national printing press strikes me as naive.

The Bushbama policy of socializing the financial losses cannot be good for the USD. Right now sentiment is being whipped up against the Eurozone countries. Sitting here, we are being tipped off by various media statements that the U. K. is next up to be attacked by speculators. I am not so sure. The next attackee, should there be one, could be right here. Just as the Germans thought that the attack onto the mainland was coming elsewhere, this talk could be misdirection. A good buying opportunity in the Euro may be coming relatively soon. If so, one would suspecct that gold prices would move up in USD terms as well.

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Dollar Strength Mostly a Mirage

The dollar is said to be "strong" lately, per the DXY chart nearby (click on all charts to enlarge). The DXY is principally a measure of the USD-euro relationship (58% weighting). 92% of the DXY derives from four currencies: euro, yen, pound sterling, and Canadian dollar.

The real world use of the dollar vs. other currencies is to trade goods and services. This is measured by the St. Louis Fed as a trade-weighted dollar.

The move in the trade-weighted dollar is almost unnoticeable lately.

Basically, we have been seeing weakness in the euro against the dollar for obvious reasons. Against other currencies, the Fed's easy credit policy has succeeded in keeping the USD relatively cheap.

I suspect that traders are gunning for leveraged speculators all over the investment map, regardless of "fundamentals". In this scenario, the markets "know" nothing, and price declines do not indicate that the "smart money" is in the process of getting out. Remember, during a half-year period in 2008, in which the price of houses in the U. S. perhaps fell 10% (who knows?), the price of oil fell 75%. Did the cost of finding and producing oil change? Not really. Did demand change much? No. Did the markets know anything at $140 or $35 per barrel? No. Did traders as a whole make money off the volatility? Yes.

Regardless of whether CNBC gold commercials sucked in a few latecomers to the gold party, the fundamental argument for gold for American investors is that the government is an irresponsible custodian of its currency. The faux strength in the U. S. dollar does not have anything to do with the longer-term prospects of the gold price in increasingly abundant printed and electronic greenbacks.

Gold will cease to be on my investment agenda when politicians stop promising much, more than they can deliver.

When will that occur?

I am reminded of a story from the 1990s, when an oversupply of natural gas looked endless and was called the "gas bubble" (not an investment bubble). Here's the story.

An oil and gas man calls to God for an answer to his woes. "God, when will this gas bubble finally end?"

God answers.

"Not in my lifetime!"

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Focus on the Trade-Weighted Dollar Index, not the DXY

Much is made of the weakness of the Euro and perhaps the yen vs. the dollar. OK, these are frail currencies.

So the DXY artificial, limited dollar index is rising. Reflexively perhaps, gold and stocks have fallen today. However, the real world has currencies to exchange in trade in goods and services. The St. Louis Fed keeps track of the broad, trade-weighted index. The nearby chart shows this visually (click on it for greater detail).

There has been NO rebound in the dollar as a currency when measured in terms of trade balances. It remains a flawed currency with dangerous fiscal policies and a Fed whose balance sheet contains an unknown quantity of impaired assets.

The zero interest-rate policy is suppressing value of the dollar where it counts, in trade. This is one of the sources of the fake boom/boomlet now underway that economists/personalities such as Larry Kudlow tout and serious players such as ECRI point out.

The downside of all this is price inflation. It's a classic trade-off. Now that the trade-weighted dollar index is around 100, where it was 2 years ago, recall what inflation was doing 2 years ago. Gold was surging to hit above $1000/ounce in March 2008; it is only up another about 10% since then despite all the financial chaos and money-printing.

If the economy has actually turned and employment is going to finally rise significantly (something not noticed by ordinary workers per the Gallup.com poll as recently as today's report), price inflation is going to far exceed interest rates paid by money market funds or most bank accounts. This will lead to more and more speculation in financial instruments. Only tight regulation (absent) and/or much higher real interests is likely to prevent said speculation.

The speculation here is that precious metals will be a beneficiary of price inflation that exceeds prevailing short-term interest rates, and that should inflation equal or exceed the 5-10 year Treasury interest rate, all heck could break loose, including new records in a variety of commodities.

Copyright (C) Long Lake LLC 2009