But first, the crisis in Greece didn’t come to a head over night but it can’t be far away. Rival political parties have been unable to form a government. New elections are scheduled for the second week in June. The financial has definitely become political. The people have run out of patience with unsound money and the world built on it.

All that said, the Greeks managed to make a €430 million payment to hold-out creditors last night. Nearly 97% of Greek creditors agreed to the restructuring of the country’s debt in March. That wiped off over €100 billion in Greek debt and resulted in 70% losses for some of the bondholders who accepted the deal. Not all of them did.

Yesterday, the bondholders who didn’t accept the deal got paid in full. There is still about €6 billion worth of debt owed to creditors who refused to participate in the restructuring. You can imagine that the Greek decision to pay the holdouts would anger the creditors who agreed to the deal. They look like schmucks now. Schmucks.

But in the current scheme of things, €430 million is chump change. The real issue is whether the Greeks are going to default on €150 billion worth of government debt. If those bonds are owned by foreign creditors – let’s call them other European banks – then the Greek crisis becomes a European crisis. We’ll come back to this issue of “containment” shortly.

For the Greek people, the most alarming aspect of what’s going on is that their life savings are at serious risk of a massive, overnight, non-voluntary devaluation. There are a lot of words for the magical process of turning one thing into something else: alchemy, transmutation, and transubstantiation come to mind. But to the Greeks it’s going to look a lot like highway robbery.

You’ll go to bed one night with your life savings denominated in euros. You’ll wake up the next day with them denominated in drachma. And your euro savings will be automatically converted to drachma at an exchange rate not of your choosing. For example, your 1,000 euros will become 100 drachma…or even 10,000 drachma. The nominal amount won’t matter. What matters is that the devaluation strips you of 70% or 80% of your purchasing power.

Most people would avoid that kind of value destruction if they could. Maybe that explains why €700 million was withdrawn from Greek banks on Monday, according to remarks made by Greek President Karolos Papoulias and reported in the Wall Street Journal. The Journal reports that between €2 and €3 billion in deposits have been withdrawn from the Greek banking system each month for the past two years. January was a high point, with €5 billion.

A bank run by any other name would look as desperate. And who wouldn’t be desperate now?

Leaving the euro, devaluing the drachma, and defaulting on debt owed to foreign creditors are Greece’s best long-term economic survival strategy. But the unavoidable side-effect is to destroy the savings of the people, not to mention usher in a period of lower standards of living.

That won’t win you many votes. It may start a revolution.

And how do you prevent the Greek precedent from being imitated by the Spanish and the Italians? To be candid, we don’t think it matters much now. Greece can’t afford to stay in the euro. The Spanish and the Italians can’t afford to leave it.

The economies and banking systems of Spain and Italy are indispensable to Europe. If they leave the euro, there is no euro. The Greeks can leave, devalue, default and use a weaker currency to claw their way back to economic competitiveness. If the Spanish and Italians leave, they lose access to private capital, they lose access to the ECB and they take down Europe’s banking system. They can’t leave. More importantly, they can’t be allowed to leave.

This makes the task of the European Central Bank (ECB) much easier. It simply has to guarantee Greek debt owed to all non-Greek creditors. Or, it could simply buy that debt. This would solve the problem of anyone outside Greece taking losses on Greek debt.

This is what corporatism looks like, when the Big State and Big Finance become the Big Power in the economy. Losses cannot be tolerated. Any loss results in lower equity capital at a financial firm would require selling assets. Since everyone owns a piece of everyone else, and owes to everyone else, any major loss in one place results in losses everywhere.

Of course it’s absurd that Europe is moving toward this kind of “extreme socialism”. The people most responsible for the crisis are not accountable and the people who have saved get punished. The elite are enriched and everyone else is enslaved.

This is why the financial crisis could so quickly become a political and social crisis. When people don’t think they can get justice from the courts or the cops, and when they think that cheating is the only way to get ahead in a system, the political and financial order is on borrowed time. The clock is ticking.

Regards,

Dan Denning

The Daily Reckoning Australia

Why Greece Can’t Afford to Stay in the Euro was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The whole European currency scheme was both brilliant and crazy. It was brilliant because Europe should have a united currency. In fact, the whole world should have a united currency. Once upon a time, it did. It was called the gold standard. National currencies were just another name for the same core thing — a nationalist spin on a global consensus. If some country had waved around an unbacked piece of paper and called it money, no one would have taken it seriously.

And the gold standard was internally policing. If one country debauched the currency, gold would flow out, the thing would lose credibility and capital would flee to places that took sound finance seriously. Governments were restrained, the hands of politicians were tied (they could only spend what they could overtly steal) and markets ruled the day. The politicians hated it, but markets were free, stable and growing.

So yes, there is a case for single currencies in regions, or even the entire world. Truly, why should people and multinational commercial institutions have to go through the ridiculous headache of changing currencies at the border? This is just pointless. Imagine if an inch meant something different in every country, and you had to come to a new understanding of its meaning in order to build on this, versus on that side of the border? Markets don’t like this kind of pointless exercise. The natural market tendency is toward unity in what matters (money) and disunity where it matters (competition and entrepreneurship).

So the European elites who cobbled together the euro after many decades of planning played to that sense, and developed a reasonable expectation of a wonderful Europe united with peace and free trade, all with a single currency. It seemed like a recreation of an older, freer, more-wonderful world. So why not?

Here’s why not: The gold standard no longer exists. It hasn’t existed since the politicians destroyed the last remnants of it in the early 1970s. And it was in 1970 that the idea of a single currency for Europe went from the dream stage to the planning stage. At the end of the gold standard, the idea should have been dropped, but it was not. The planning elites had it in their heads that this was the only way forward, and nothing would stop them.

A single currency seemed like a great idea to the relatively weak economies of Europe. The lira, peseta, escudo, franc and drachma would no longer suffer at the hands of traders who seemed to forever cling to the German mark. They could inflate without consequence. Knowing this to be a problem, the pro-euro planners cobbled together certain safeguards. There would be a single central bank, and sovereign countries would have to give up autonomous control over monetary policy. The same would apply to national finance: no more endless running of deficits, and no more free-spending legislatures.

As a condition of entering the currency union, countries would have to agree to all these terms and more, including harmonized regulatory systems. Governments would have to confess their prior sins and swear on a holy copy of the EU Constitution that they would be good from now on. Well, that didn’t happen, but the planners were so dead set on the notion of a single currency that they decided to look the other way. All these entered the union with debt and broken banking systems, all in a sort of collective hope that the whole could cover the sins of the parts.

Sure enough, the southern countries experienced a wonderful boon following the introduction of the euro. Interest rates on government bonds fell dramatically — not because their citizens were suddenly saving, and the banks were flush with capital. The reason was the new perception that the European Central Bank would operate as a guarantor of the debt of all eurozone countries. In other words, rates fell in Europe for the same reason they fell in the United States: The centralization was creating a moral hazard.

This set off a lovely economic boom that later led to bust, there just as here. The central bank, however, had already promised that it would not be involved in any bailout schemes, that it would only fight inflation. This was a strange repeat of history because this is precisely what the Fed had claimed when it was created too. Central banks always say this at the outset: We will sleep with the money, but we won’t actually do anything. We will resist every temptation!

The problems here are incredibly obvious. Countries had not actually given up all their fiscal authority. Most importantly, their banking systems still had control and, thanks to fractional reserve banking, they still could create money, and in a way that the central bank could not control. This too is a consequence of not being on a gold standard that automatically regulates and restrains the banking systems.

Now, each national banking system, and even each bank, ran its own discretionary policy, with the implicit (but never stated) guarantee from the central bank that it would never let the system fail. Worse, every country in Europe had to accept this money.

Economist Philipp Bagus of Juan Carlos in Madrid observes that the whole system embedded a kind of monetary imperialism from unsound economies to sound economies, dragging down economic structure and poisoning the whole system with the viruses of the worst states. If this story sounds familiar to Americans, it should. This is the same problem that gave rise to the crazy real estate boom in the U.S. and the subsequent meltdown. It’s our old friend Mr. Moral Hazard, but operating across the entire eurozone.

Hans-Hermann Hoppe, the economist who predicted this whole scenario in the early 1990s, observes that this centralization is the inevitable path of paper money regimes, as governments constantly seek higher and higher authorities to expiate their sins. With each step, the money gets qualitatively worse and the imposition of economic controls becomes ever more tyrannical.

What is the way out? Everyone is now talking about the restoration of national currencies, and while that is a better approach than standing by as the entire system collapses and the contagion spreads around the world, it is not as easy as it seems. Every country that wants to reassert its national currency will have to give up its debt addictions and clean up its fiscal house. The banking system will have to be deleveraged. Industries sustained by the euro subsidy will have to go belly up.

If this fantasy actually became true, it would be entirely possible for any one country (hint: Germany) to adopt an authentic gold standard, perhaps inspiring others to do the same. The end result — we are talking about a decade-long process here — could, in fact, be another single European currency, a sound currency rooted in reality and not the hallucinations of politicians and financial elites.

How much tolerance is there in the world today for such pain? You need only look at the U.S. situation to get an idea. The technocrats in charge today are completely unlike those of yesteryear. They will not permit wholesale deleveraging. They believe that they have to tools to prevent all pain, and the political systems of the world are structured to punish anyone who thinks about long-term gains over short-term pain. If you doubt that, take off an evening and watch the Republican presidential debates.

Regards,

Jeffrey Tucker

The Euro Crackup was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

On the news, the franc fell off a cliff, dropping almost 10% INSTANTLY. Gold priced in Swiss francs jumped from 1497 to 1620 per troy ounce, all in about 45 seconds.

Precious metals are now all alone as the only forms of sound money that are truly safe havens.

Just 6-weeks ago on July 27th, in a letter entitled “Should I buy gold at its all-time high”, I wrote:

“Even stronger currencies like the Swiss franc have limits to their appreciation. At some point, the Swiss National Bank will impose capital controls to thwart the rise of its currency. . . [Y]ou’ll probably feel like a sucker for not buying gold at $1600 when you still had the chance.”

Since then gold has soared roughly 20%, and as of this morning, the SNB has imposed capital controls to thwart the rise of its currency.

This is just the beginning.

The Swiss government has basically told the world that they will print as much money as it takes, and buy up as much crap sovereign debt as they can, to competitively devalue the currency.

This essentially puts Switzerland in the same sinking boat as Italy, Greece, and Portugal… with one key difference: Switzerland has 0% interest rates.

In other words, you can now borrow in francs at 0% and buy government-backed euro garbage yielding 5%, 10%, 30%…. with absolutely no downside currency risk.

Here’s a practical example you can do — open a FOREX trading account and borrow Swiss francs at 0.5%. Buy the EURCHF cross and simply hold euro cash, paying 0.65%. At 100:1 leverage (quite common in FOREX trading), that translates into a 15% return simply for HOLDING CASH with no downside currency risk.

It’s free money, courtesy of the Swiss National Bank. I’m just waiting for the next wave of margin hikes.  Needless to say, this is utter madness and will absolutely hasten the end game for Europe.

A few other points to make:

1) Big Swiss exporters like Novartis and Nestle are dancing a jig right now as this will surely boost their sales in the short-term. Also, banks in Switzerland and Austria who had heavy exposure to Eastern Europe are breathing a sigh of relief right now.

You see, Swiss interest rates have traditionally been lower than in Europe’s emerging economies. For example, many Hungarians took out mortgage loans in Swiss francs because the borrowing rate was so much cheaper.

Once the Swiss franc began to rise, however, borrowers had a difficult time paying back the loan; suddenly their mortgage payment and balance were much higher than before, and default rates soared.

Banks in Austria, Germany, and Switzerland who wrote most of the loans were sitting on huge potential losses… and this destruction to the financial system has been mitigated thanks to today’s move. I have to imagine this had some influence in the decision.

2) For all the talk of a pullback in gold, this is only further reason for a rise in precious metals. It’s true that nothing goes up (or down) in a straight line, but given that the world just lost nearly its last remaining safe haven currency, there are few other asset classes to turn to.

3) Markets are not functioning properly. Competitive devaluation means that governments are all striving to out-print each other… Europe is printing as much as they can to bail out the PIIGS, Switzerland just signed up to join then, Japan and China are not far behind, and QE3 is set to launch soon in America.

With so much money sloshing around the financial system, there is absolutely no sense of value anymore; people cannot invest with confidence given all the massive bureaucratic intervention.

4) In the Swiss National Bank’s brief statement, they said “With immediate effect, [the SNB] will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.”

The three key words here are ‘WITH IMMEDIATE EFFECT’. This is just another example of a government making instant changes that pose dramatic risk over people’s lives and livelihoods.

Make no mistake, we can all wake up tomorrow to a new reality.

Regards,

Simon Black

With Immediate Effect was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

I mention these events reluctantly, knowing how averse we Americans are to news out of Old Europe, that boring backwater of sclerotic cafe lay-abouts, socialistic train service, and less-than man-sized portions of things that real men don’t eat anyway.

The question begging itself here, of course, is how Europe intends to come up with roughly a trillion in bailout money. Sell Portugal to China? Cut Greece up into bait and catch whatever fish are left in the Mediterranean Sea? Frankly, I’m stumped. Talk about robbing Peter to pay Paul…. All the European nations are already so hopelessly enmeshed in chains of unfulfillable counter-party obligations that the bailout might as well be a game of musical chairs played in the Large Hadron Particle Collider, set to the tunes of Karlheinz Stockhausen. The European bailout is, in fact, an absurdity. I predict that the effect of the announcement will last all of one trading day on the stock markets.

The truth is that the imbalances of global finance are so grotesque now that the whole money system is hanging together with nothing but spit and prayer. I get rafts of e-letters every week warning of a supposedly-coming global currency — a companion idea to the notion of a one-world government. Both are fantasies. Events are taking the nations of the world in the other direction: towards break-up, down-sizing, down-scaling. Likewise, if major currencies such as the Euro and the dollar blow up, they’re much more likely to be replaced by more local bank-notes backed by gold than by some hypothetical Amero or Globo-buck.

At seven a.m. Eastern time, the European stock markets were zooming, and Bloomberg even carried a wonderfully mysterious headline saying Greek Bonds Rally. That was especially rich — like, who in the **** is going to load up on Greek bonds now? Is there a pension fund somewhere run by such dimwits that they would sell their positions in the Goldman Sachs issued Wolverine CDO in order to get in on the new bargain in ten-year Greek sovereigns? I hope those pensioners are prepared to spend what remains of their lives selling chestnuts from pushcarts on the streets of Oslo, because they sure won’t be clipping coupons in front of any World Cup telecast.

As if life in the USA wasn’t surreal enough last week. Once upon a time, the stock market was a  place where people with capital went to look for productive activity to invest in — say, a company devoted to making soap flakes, an underpants factory. Now the market is a robot combat arena where algorithms battle for supremacy of the feedback loops.  Thursday’s still-baffling fifteen-minute “crash” was an excellent demonstration of the diminishing returns of technology. People too-clever-by-half, aided greatly by computers, have now gamed the investment indexes so successfully that these markets no longer have anything to do with investment — they’re just about shaving micro-points of profit at high volumes by micro-milliseconds off mere differentials in… math! This is truly quant heaven, a place where only numbers matter and there is no correspondence to anything in the real world. In other words, last Thursday’s bizarre action was a warning that the American stock markets have flown up their own aggregate ass.

These algo-robots may be elegantly complex, but they are really no more than triggering mechanisms, and Thursday’s — whatever it was — glitch, let’s say, ought to be regarded as a mere preview of coming attractions for a full-on feature cluster**** in which the putative contents of these stock markets get sucked into a black hole so vast that the trading desks will have to find a way to arbitrage infinity to ever again catch a glimpse of America’s receding wealth. And it could all happen in a finger-snap.

Why would anybody not heavily medicated stay invested in the stock markets? Well, the answer must be that they’re not. The few still hanging around are the institutionals with nowhere else to go, the pitiful pension funds or the pathetic college endowment funds desperately chasing “yield” in a world where once-sturdier instruments yield zirp-o — and these poor chumps are getting played and played out. The only other remaining marketeers are — you guessed it — the too-big-to-fail banks, the Federal Reserve, and possibly the US Treasury itself playing front-running games and algo stunts and black box buy-ups, and carry-trade rackets, and — let’s not forget — outright swindles.

We tend to forget that all this hugger-mugger once had a relation to real economies. The basic truth about real economies — at least the industrial-strength ones — is that they cannot be successfully managed on the basis of revolving debt in the context of no growth — and no growth is exactly the bottom line of the peak oil story so revolving debt is finished for now. Speaking of oil, the Deepwater Horizon disaster (still ongoing) has gotten so boring to the editors of The New York Times that further news about it has been banished from the front page of the paper. Too depressing, I guess.

In the meantime, though, rest assured that whatever else is going on out there, credit default swaps never sleep.

Regards,
James Howard Kunstler
Whiskey & Gunpowder

May 10, 2010

Greek Bonds Rally and Other Unrealities was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Eurozone’s problem? In short, it’s history…precisely what the single currency was supposed to neuter, of course.

Greece’s still-pending €110bn bail-out has already cost three lives in Athens’ riots yesterday. More bloodshed inside Western Europe would make a horrific end for this grandest of grand post-war projects…the crowning achievement of Europe’s longest-ever period of peacetime.

But thanks to history — and the very same history that built the Euro, as well — Germany cannot inflate. The rest of Europe, however, cannot do anything else. Sharing one printing press was always unwise. Now it makes UK prime minister Gordon Brown look smart for staying outside. Which really is saying something.

No “single currency” could ever reconcile history, however, because Europe’s monetary politics over the last 100 years is cleft right in two. Germany suffered first hyper-inflation…and then madness…before banishing the shame of cattle-trucks packed full of people by promising “Never again!” to wheelbarrows overflowing with bank-notes.

The rest of Europe, in contrast, and especially the PIGS of the south (but also Great Britain, you’ll note), got things the other way round. Deflation came first, thanks to the interwar Gold Standard. Victory in Europe was then followed by the victory of soft money. Time and again, devaluation worked magic to rescue over-spent nations from ever settling their debts.

So, where Germans look back and see catastrophic inflation…followed by the sins of the Führer…and finally a five-decade boom built on sound money (not to mention cream-laden lunches)…Greek, Spanish and Italian civil servants fondly recall an insane scramble for cash, only redeemed — repeatedly, and for the next 50 years — by default through debasement.

The hyper-inflation of 1919-1923 is scorched onto Germany’s collective conscience and Germany’s alone. To the west of the Rhine and everywhere south of the Alps, a very different 20th century applies. Their only memory of tight money was the disaster of the Great Depression. Spared hyper-inflation in the 1920s, Europe outside of Deutschland slipped instead into chronic deflation the following decade. Come 1931, the world’s monetary anchor — the international gold-exchange standard — was cut loose from the Pound, forcing everyone else to do the same sooner or later.

Sooner was better, as well. Inflation worked. So did the war. Just ask Paul Krugman or Ben Bernanke.

“You owe us €70 billion for the ruins you left behind,” spits the mayor of Athens, Nikitas Kaklamanis.

Deputy prime minister Theodoros Pangalos cuts nearer the heart of the matter by adding how “The Nazis took away the Greek gold that was in the Bank of Greece. They took away the Greek money and they never gave it back.”

Germany should cough up, in short, for the sins of the Führer. Which is kind of correct, since Hitler’s greatest achievement today is a welfare state that neither the Allies or Axis could ever afford.

Compare and contrast with the crushing demands made after WWI. Denied a knock-out blow on the battlefield, the French and British sought victory at Versailles instead…squeezing the Hun for more money than yet existed in the form of gold bullion. Whereas today, “Greek civil servants are suffering because of a crisis they didn’t cause,” reports the BBC. Only they did cause it, of course — or rather, their parents did…like everyone else who survived or was born after WWII…by voting themselves a cradle-to-gravy-train welfare state that hasn’t stopped paying ever since.

The irony of Greek civil servants demanding 16 months’ wages each year from German taxpayers runs deeper than it seems at first glance. The inevitable response by central banks takes us straight back to Weimar, as well.

“What might therefore take place in the long term?” asks French economist Patrick Artus at Natixis of the single Eurozone project. The options he sets out are nigh-on impossible:

• the launch of a federal system (taxes, spending and central control), “which is highly unlikely given Germany’s stance”;

• a continued gap between permanently depressed member states and high-growth prosperity elsewhere — “difficult to accept both politically and socially”;

• withdrawal from the Euro, ignoring the costs, by “irrationally populist governments in the countries experiencing the greatest difficulty…”

Option 1 would force that political union which Helmut Kohl first sought, but the rest of Europe refused to accept. A pan-Eurozone council would hardly help German politicians cool tabloid demands to reinstate the Deutsche Mark, either.

Option 2 is also too ugly to bear, since ignoring the growth-gap only prolongs and worsens the anger, delaying the catastrophe that is Option 3. Watching the Eurozone project — the end of history, no less, for the people who built it — collapse into social unrest inside Western Europe would be just too ironic at best. It might end six decades of peace at worst.

So what about Option 4 — which Artus ignores — by re-opening Germany’s print-shop in Frankfurt?

To date, the plan for bailing out Greece, and thus preserving the Euro, means giving Athens enough money to save it asking the markets for funding until 2014. That sum, so far, is put somewhere near €120bn. But to date, Greece’s Eurozone partners have offered up diddly squat. Italy and Spain, in particular, have gone very quiet.

Wheeling out the printing press in Frankfurt, however…and getting the European Central Bank to do precisely what Havenstein did in 1920…means Europe can pay its pensioners the same way the Weimar Republic tried to pay Britain and France after Versailles, and with the same inevitable outcome, as well.

Just like British and French pride in 1919, today’s heroic welfare promises are just too expensive. Whether sooner or later…and with or without a hyperinflation to try and pay off the victorious pensioners and civil servants…these costs from the past cannot be paid from tomorrow’s money. They’re simply too big.

Regards,
Adrian Ash
BullionVault
for Whiskey & Gunpowder

May 6, 2010

Gold, the Euro, and German Hyperinflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

But we had serious and complicated legal, financial and economic discussions. Fiat currency, fractional reserve banking and derivatives have completely broken the pricing mechanism. A tiny volcano burps and entire transportation systems grind to a halt. We addressed tough questions about survivalism in the suburbs. And then focus turned to the timing of the evaporation of the FRN$.

Euro Gold

But the FRN$ is below the Euro in the liquidity pyramid. The FRN$ has deeper capital pools, more economic underpinning, greater liquidity, a stronger economic union and more thoroughly self-deceived owners of colored coupons and imaginary digits. Therefore, the Euro will evaporate before the FRN$. And that is precisely what is happening.

Fiat currencies represent the common stocks of nations, or in the Euro’s case the common stock of a weak coalition of nations. Since gold is the numaire par excellence then lets take a view at the Euro zone’s stock through that lens.

A few weeks ago when I was around Doug Casey he remarked that the Euro will be gone in about five years. As the above chart shows, the Euro has lost about 75% of its value in the last 10 years. Mr. Casey may be slightly optimistic about this particular intrinsically worthless colored coupon that represents the common stock of that monetary union.

Euro Zone

So what has happened in the Euro zone as its common stock has been evaporating? Government budgets have exploded, economic output has slowed, individuals are rioting and causing material amounts of damage, governments are being toppled and armed forces, despite being prohibited by the law that they ultimately enforce, are striking.

For example, on 26 April 2010 King Albert II of Belgium accepted Prime Minister Yve Leterme’s colation government’s resignation after futile blathering to resuscitate the government dissipated. This highlights one of the common themes in Europe as Belgium is a prototype of cultural differences with French and Dutch speaking communities disputing while the government debt as a percentage of GDP is over 100%. These giant parasitical vampire squids cannot be supported by the underlying  livestock base. But a friendly tip, if you are in Bruges be sure to get a waffle as they are delectable.

Another fun example, also on 26 April 2010, hundreds of Greek air force pilots called in sick. Sure, these armed services members are not legally allowed to strike but such civil disobedience happens when members of the enforcer and brutalizing class do not get their paychecks or those paychecks are reduced due to ‘austerity measures’.

Sure, Greek Finance Minister George Papaconstantinou incoherently babbles about cutting the budget deficit through structural reforms instead of salaries but the truth of the matter is that government, like the vampires in Daybreakers, would rather suck the humans dry and then die than curb their appetite and coexist. It is economic law, not voluntary restraint by the vampire squids, through undulating waves of mass psychology that forces limited government.

Despite what Merkel and Germany do the die is already cast with regards to the Euro and Euro zone. Interest rates must go up and the market is already forcing this with rises in debt default insurance rates. Additionally, the European banking system is still in terrible condition. On 23 April 2010 Moody’s lowered National Bank of Greece’s credit rating one grade to A3/A. Other Greek banks will likely be downgraded such as Emporiki, Agrotiki Bank, Piraeaus Bank, Eurobank, and Alpha Bank. Plus, Belgium banks need to be cleansed along with plenty of other banks throughout Europe from England to Austria and France to Norway.

The Euro Is Broken

The Euro is broken. This was its destiny. This is the destiny of all fiat currencies. These bureau-rats cannot stop this anymore than Cnut the Great could command the tide to halt. If these impotent bureau-rats are so powerful then why did they fail to pass legislation commanding the ash cloud to disperse?

So what will a post Euro Europe look like? Hopefully, the Europeans do not go back to doing what they have been doing for thousands of years. But those are some of the ominous clouds on the horizon.

Conclusion

Gold has hit record highs around €860. The Euro is the only possible fiat contender as the world reserve currency and for rational investors it fails muster. Like the Euro the FRN$ is destined to evaporate but this will likely happen later and over a longer period of time.

As the political situation continues deteriorating in Europe holders of capital will continue turning towards the precious metals to protect and preserve their wealth. Europe has a rich culture, delicious foods and fine art. Hopefully I will be enjoying it next month and at a lower cost because of the evaporating Euro.

But Europe also has a savage past that only the vampire squids desire to see again. After all, luring countries to increase their debt load while destroying the production and productive capacity is bad for everyone but the sociopathic bankers. And I should be gone before that happens.

Regards,
Trace Mayer
RunToGold.com
Whiskey & Gunpowder

April 27, 2010

Euro Gold and the Euro Zone was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Unlike in the past, the debt markets won’t just roll all that Greek debt over to some future time. No more kicking the can down the road for others to deal with. Beware of Greeks bearing gifts, right?

In Greece, they’re faced with the hard fact that they have too much government and not enough productive economy.

Even with their backs to the wall, the Greek politicians won’t make painful budget cuts. Greece needs a miracle — if not a bailout — just to keep the lights burning and the civil servants paid.

Oh, and just as an aside… Does this seem similar to what’s going on in California, or New York, or Michigan, or maybe even the whole United States of America? As that ancient Greek philosopher Plato once noted, “If the sandal fits, wear it.”

What’s happening in Greece is a dress rehearsal for the tragic drama that’ll play out in the U.S. over the next generation or so. Too much government, too many obligations and not enough money to pay for it. To use a Greek concept, it’s destined. Something has to give, and my bet is that sooner or later, the U.S. dollar will go Greek on us.

Now for some irony. (That’s a Greek word, from eirōnikós, meaning dissembling or insincere.) The Greek bailout has led to a drop in the value of the euro relative to the U.S. dollar. So the Greek monetary crash has been bad for the euro and good for the buck — for now.

But people everywhere want only so many dollars. Then what? Greece’s problems have created a floor under gold and silver prices, and by extension beneath the precious metal miners. That floor is spreading outward, and supporting energy prices as well. (So what’s bad for Greece is basically good for the OI portfolio.)

After Hubris Comes Nemesis

Where do things go from here? We’re in the opening scenes of this Greek drama. There’s much more excitement ahead.

The European Union is 10 years into its common currency, the euro. And the bad habits of decades past are starting to show up and spoil the party.

British commentator Ambrose Evans-Pritchard unloads with both barrels. “The last two weeks have cruelly exposed the Original Sin of monetary union,” he states, “that EMU [European Monetary Union] was launched without an EU treasury or debt union. This will be tested again and again by bond vigilantes.”

Europe, Greece and the euro should be so fortunate as to have to deal only with bond vigilantes. James Howard Kunstler posed the question a different way, asking, “What happens to the vaunted peacefulness of contemporary Europe now that the narcotic of universal prosperity is wearing off… New animosities [may] burble out of those lovely old streets.”

“Narcotic” or not, there’s open speculation that the euro will fail as a currency. British Member of Parliament Daniel Hannan, writing in the U.K. Telegraph, leaves no doubt about his opinion. ”The euro won’t last!” he declares. “It has only ever known prosperous times! This is its first trial, and it will fail! After its hubris comes its nemesis! Woe, woe, woe sings the chorus.”

Not to be outdone by the chorus, the German Bundestag has drafted an opinion stating that a grant of aid to Greece is illegal. Thus, per German diktat, state bodies are forbidden to purchase the debt of another state in any manner whatsoever. Thus do the Germans dig deep — to their inner Prussian desire for order — and hurl down the gauntlet. Nichts for the Greeks.

Can you fault the Germans? Germany is a nation of high industrial productivity and strong monetary discipline. It can’t abide, and will not subsidize, the free-spending habits of the fiscal libertines down in Greece (not to mention Italy, Spain and Portugal). The usually polite German magazine Der Spiegel pulls no punches last week, entitling one article “Lies, Damned Lies and Greek Statistics.”

Another German newspaper, the Frankfurter Allgemeine, summed up national sentiments when it asked why German taxpayers should bail out a country that thinks it impolitic to raise the retirement age to 63. “Should Germans have to work in the future until 69 instead of 67 so that Greeks can enjoy early retirement?”

Who wrote that, Count Bismarck? Ouch.

The German Comparison

Compared with Greece — and with most other countries of the world — Germany has its economy and government spending under control. Not only that, the German fiscal and monetary house is in order after paying out big money for the past 20 years to integrate the former East Germany into the unified nation. It’s been a long, expensive, even painful effort.

Meanwhile, Germany has achieved national prosperity by following a path that seems odd in this age of globalization and guilt-free outsourcing. For example, Germany has strong labor unions. The unions have bargained for high wages and excellent benefits for industrial workers. It makes for expensive production costs.

And Germany has a strong environmental movement. Among other things, the Green Party has been instrumental in Germany closing down much of its nuclear power capacity. The environmental emphasis makes for another element of economic handicap in a cutthroat world where pennies count in every element of unit cost.

Then there’s the fact that Germany imports most of its raw materials, certainly a lot of its energy. Germany even imports large amounts of natural gas from Russia — a nation with which the Germans have had some unpleasant dealings over the past century. So energy and input costs are high, as well.

When you look at it, the Germans are not at all out of line to balk at bailing out Greece. But it still gets back to what it means for the future of the euro. And if the euro fails, what does it mean for the dollar? By extension, if the euro fails, what does it do to precious metals, energy resources and the firms that extract these substances? It’s something to think about.

Until we meet again,
Bryon King

February 22, 2010

Greece, Germany, Gold, Oil and the Dollar was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

As you may know, California is bankrupt. That ball got rolling back in December 1994, when Orange County declared bankruptcy. Once one of the most prosperous districts in the state, it watched a pool of riskily invested and highly leveraged money go south, and the game was up. After losses totaling $1.6 billion, a liquidity trap was sprung from which Orange County’s Treasurer Tax-collector Robert Citron could not escape.

Although considered somewhat of an isolated incident, it wasn’t long until related problems began to emerge. Now the state faces endless traffic jams, aging schools and hospitals, falling cash accounts and an annual budget more dependent on volatile tax revenues than at any time in state history. And it looks like the crunch will come to a head under Gov. Arnold Schwarzenegger. But here’s the real problem.

All by itself, California is the eighth-largest economy in the world. So its bankruptcy would spell trouble for those that are interconnected with it — especially neighboring states that depend on California’s economic machine for their own growth.

But does California care? It doesn’t seem that way. Its state budget is larger than any other in the United States ($56 billion). And yet that still isn’t enough money to keep it out of trouble. It refuses to live within its means, and is determined to borrow at ever-increasing levels. For proof, remember that California voters rejected a bill that was really called, “The California Live Within Our Means Act.”

Why the arrogance? Perhaps it believes the Fed will step in with a bailout. After all, billions and billions have been given to private corporations… why shouldn’t a state benefit equally — especially if it would sink the U.S. economy otherwise?

But the corporate bailouts came with strings attached. So it’s easy to see the government telling the state to take action to get out of its mess. Reduce spending, cut programs and implement austerity programs until California’s budget is actually balanced.

Then make the very real threat to exorcise it from the Union if it doesn’t comply.

I’m sure you’re saying, “Wait, wait, hold the phone! Nobody is talking about this. There’s no chance that California is going to be kicked out of the United States”

And I am sure that you’re right. But we’ve heard very similar language used when it comes to talking about Greece and the European Union. And, in fact, that’s what today’s commentary addresses. Is it more likely that Greece will be removed form the European Union than that the state of California will be removed from the United States? After all, there are some similarities that make the comparison of the two cases worth considering.

Will California Go Greek?

Each party, Greece and California, are members of a union or conglomerate of political entities. Each one shares a united currency with the others in the union. Each one has particular trade interrelations as well as financial interrelations with others in the union. Lastly, each is “bankrupt,” and that has a certain dilatory effect on those around it.

As you may know, Greece has gotten a lot of bad publicity of late, and it has really hurt the euro — down around 10% in the last few months alone. Does the negative position of the Greek economy warrant such a drag on the European Union as a whole? Generally, they are only considered to be about 2–3% of the economy as a whole. California, on the other hand, is a little more than 10% of the U.S. economy as measured by GDP.

Thus, in theory, Greece should only drag down the euro by 3% on balance, but California should drag down the U.S. dollar by 10%. Overall, then, the USD should have fallen total of 7% against the euro… all things being equal.

But the problem is — all things are NOT equal. Here’s why.

California is a part of a 235-year-old republic. Even though it has not been a member for that same period, it nevertheless is a part of a union that has stood many difficult tests of time.

On the other hand, the European Union is still an experiment. It is barely out of adolescence, and we don’t know yet if it will even grow to stand among the older economies of the world. Also, even though both parties are entities in union structures, the structure of each union is different and addresses problems differently. The long and short of it is that California’s position in the United States is significantly more substantial than that of Greece in the European Union.

So right now California looks like a keeper and Greece a goner. If Europeans are reluctant to break up their happy (till now) Union, they only have a few options:

1. The European Union offers “solidarity” but no financial support.
2. The European Union offers a unified fiscal support from all members.
3. The European Union designates the stronger countries to subsidize the Greeks.
4. A mixture of numbers 2 and 3. Many have maintained that a bailout would be a violation of the Maastricht Treaty, the paperwork that created the European Union. However, the treaty itself is somewhat like a vicious dog that has no teeth or claws.

Here is an excerpt from the consolidated treaty, a piece that is commonly called the “No Bailout Clause”: The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. There you have it… NO BAILOUTS.

However, when a member does get into fiscal hot water, that language is no longer effective or applicable. At that point Article 100 takes over. It reads: Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision taken. NOW, there you have it… BAILOUTS PERMITTED.

I only give you that so you are aware that bailouts can and will be formulated in the upcoming disasters. And they do not violate the treaty itself.

However, the bigger question remains, if the European Union allows fiscal support for Greece, does that mean carte blanch permission for others to run to the EU money window and collect assistance for their carefree spending days?

It certainly seems to me that if the European Union makes this decision, which, as we have seen, is fully allowable by law, it will lose all credibility. And that may be the only thing that stands between them and ruination of the Union. It may end up collapsing on itself, even if no members ever leave, and its downfall will be the loss of confidence in the currency.

So then, how much further could the euro fall? Could it go all the way to parity? Most certainly. But before that point we will likely see many waxing and wanes of each side of the currency pair. We see a little rebound in risk appetite.

But what does all this mean for the United States and its currency?

The United States

Philosophically and economically, the United States is on a rendezvous with history… unfortunately, the path we are taking is a crash course. Many people have to come realize that we are nearing the end of a gigantic global economic experiment. No one has really walked this particular path before. A circumstance where every major nation in the world (and many minor ones too) is utilizing paper currency that has no backing of any value except for the promise of the issuing government. And we have all come to see what that is worth.

And as the saying goes, the bigger they are, the harder they fall. No currency is bigger than the U.S. dollar. No economy is bigger than that of the United States. When it comes, great will be the fall of it. Fortunes will be made. But so long as it remains the reserve currency, it is very difficult (although not impossible) for it to collapse.

It is difficult because each time it falls and gets cheap to buy, there are many who still buy it because the majority of the world’s goods are priced in U.S. dollars. So when the dollar gets cheap, so do the world’s commodities to those who are buying in currencies other than the dollar.

For us here in the United States, a cheaper dollar means more expensive everything: gas, groceries, cars… you name it. But when the dollar is cheap and other currencies are strong, it becomes a good time to stock up. Such buying will continue to prop up the dollar until a different reserve is found or created. Since such a thing will not occur overnight, the prospect for currency fluctuation over the next several decade — and our opportunity to profit from it — will be tremendous.

But make no mistake: the dollar is in trouble — one foot in the grave and the other on a banana peel.

Regards,
Bill Jenkins

February 19, 2010

Will California Be Removed from the United States? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

This analysis covers five factors:

1. Technical analysis
2. Politics
3. Commitment of traders (speculation vs. hedging) of currency futures
4. The carry trade
5. Fundamentals

Let’s kick off with the technicals.

Forex traders will note that charts marked with an asterisk are inverse of normal trading pairs. This was done to put all the currency pairs in the same frame of reference (e.g., a weakening chart on a currency pair is bullish for the U.S. dollar and U.S. dollar index).

Yen/U.S. Dollar (Monthly)*

Euro/U.S. Dollar (Weekly)

Canadian Dollar/U.S. Dollar (Monthly)*

U.S. Dollar Index (Weekly)

U.S. Dollar Index (Monthly)

The charts show that we are at a significant inflection point on the U.S. dollar index, the yen, and the euro. Let’s look at additional factors to see if we can gather insights as to which way the charts may break. Following is the political perspective.

Congress Takes Aim Over Yen

The Financial Times is reporting, “U.S. Congress Takes Aim at Tokyo Over Yen”:

“Powerful House Democrats are pressing the Bush administration to persuade Tokyo to strengthen the yen, claiming the currency’s weakness is bolstering Japanese imports at the expense of U.S. manufacturers.

“In a letter to Hank Paulson, U.S. Treasury secretary, the House members alleged that Tokyo was pursuing a cheap currency to subsidize exporters and urged Mr. Paulson ‘to press the Japanese government to reverse their weak yen policy.’

“The pressure from Democrats sets up a confrontation with the U.S. Treasury secretary, who argues the yen’s weakness reflects Japan’s economic fundamentals, rather than a deliberate policy of manipulation…

“Michigan Rep. Sander Levin, chairman of the House Trade Subcommittee, told the Financial Times: ‘Japan is clearly following policies to maintain a weak yen.’

“The yen’s fall continued on Thursday, down 0.4%, to Y121.20 against the dollar, and 0.6%, to Y157.90 against the euro.

“Japanese exports as a percentage of gross domestic product have — at 16% — surpassed the levels of 1985, when Japan was forced to revalue under pressure from the U.S.

“Takatoshi Ito, a member of the Japanese cabinet’s council on fiscal and economic policy, said: ‘Japan has not intervened since March 2004 — not even oral intervention — so the ministry of finance is clean as market fundamentals push the yen weaker.’

“Tensions over the yen are set to be reflected in legislation drafted in the Senate on currency manipulation, analysts said.

“Rep. Barney Frank, chairman of the House Financial Services Committee, said: ‘This is directly tied to the administration’s efforts to get trade promotion authority renewed. It cannot be the case that we will let the status quo go on.’”

Comments on Taking Aim

• The Democrats in Congress believe that higher prices on goods from Asia (nearly everything but food, energy, planes, and weapons) will be a good thing. It won’t
• The Democrats also must think that higher prices on goods will bring back manufacturing jobs to the U.S. They won’t
• Michigan Rep. Sander Levin, chairman of the House Trade Subcommittee, says, “Japan is clearly following policies to maintain a weak yen.” Hmmm. Like we are not doing everything in our power to maintain a weak dollar? Does any country want a strong currency? The answer to that question should be obvious: Competitive currency debasement is everywhere you look
• Takatoshi Ito, a member of the Japanese cabinet’s council on fiscal and economic policy, said: “Japan has not intervened since March 2004.” That is the fact. And oddly enough, the yen did not plunge until Japan stopped intervening. That goes to show you two things: 1) A primary trend in currencies or anything else cannot be defeated by manipulation, which is something gold bugs need to remember when screaming about these conspiracy theories purported by the Gold Anti-Trust Action Committee, and 2) sentiment was so universally bearish on the U.S. dollar by the spring of 2005 with numerous magazine covers and the shoeshine boy telling everyone that Gates and Buffett were short the dollar; that the dollar was bound to rally
• If Congress takes action against either China or Japan as currency manipulators, I fully expect a severe market reaction, and that reaction will generally not be welcome anywhere
• While cautioning against underestimating the shortsightedness of legislative bodies in general, this jawboning is more than likely nothing more than frustration by Congress and this administration that we can no longer bully the world markets into doing what we think is in our best interest (and on that, we are not even right). After all, who wants higher prices across the board on all kinds of goods and services when it will not bring a single job back to the U.S.? That is essentially what Congress is begging for.

Paulson Sides With Japan

Bloomberg is reporting, “Paulson, in Congress, Sides With Japan on Yen”:

“Henry Paulson’s defense of Japan’s currency policies over the last week is forcing traders to pay more attention to a U.S. Treasury secretary than they have in years.

“Paulson caused fluctuations in the yen at least three times in the past week by responding to questions about whether it is undervalued, as alleged by some Democrats and European finance ministers. He sparked an hour-long slide yesterday when he told the House Ways and Means Committee that the currency is set in an open market and that Japan is still struggling with deflation…

“Paulson first discussed the yen’s slide against the dollar on Jan. 31. Answering a question during testimony at the Senate Banking Committee in Washington, Paulson said he’s watching the yen ‘very, very carefully’…

“The testimony was only Paulson’s second since Bush nominated the 60-year-old for the Treasury post in May. It took Paulson three months to even mention the dollar. When he did, he said he favors a ‘strong dollar,’ a script developed by fellow Goldman alumnus Robert Rubin, who was Treasury secretary from 1995-1999.

“‘He has a very hands-off approach to markets and doesn’t seem to want to comment very much,’ said Sophia Drossos, a currency strategist at Morgan Stanley in New York. ‘He brings a high level of financial savvy. He is viewed as the Republicans’ answer to Robert Rubin’…

“Paulson’s remarks may also have had an impact because investors are growing wary about the magnitude of the yen’s decline. The currency is near a 20-year low on a trade-weighted basis, and Commodity Futures Trading Commission figures on Feb. 2 showed a record 173,005 positions betting on a weaker yen…

“‘As soon as he mentioned that he was watching it very closely, that gave traders something to run with,’ said David Gilmore, a partner at Foreign Exchange Analytics in Essex, Conn. ‘It took literally a couple of days for the market to fully understand,’ he said.

“Paulson ‘did an admirable job’ in cogently laying out his view, Gilmore added. ‘The interesting thing is that he was so prepared to speak on the yen.’”

Comments on Paulson

• Supposedly, Paulson is watching things “very, very carefully.” So what? Is the U.S. going to sell dollars and buy yen? Wouldn’t that be fun? (Especially if Japan reacted as it did before, by selling yen to buy dollars)
• Sophia Drossos, a currency strategist at Morgan Stanley, said: “He has a very hands-off approach to markets and doesn’t seem to want to comment very much,” and “He brings a high level of financial savvy. He is viewed as the Republicans’ answer to Robert Rubin” OK, Sophia, if his approach is hands-off, exactly why should anyone care what he is watching, or, for that matter, saying? Why does that make him “savvy”? Is he really Robert Rubin?
• David Gilmore, a partner at Foreign Exchange Analytics, had to say: 1) “As soon as he mentioned that he was watching it very closely, that gave traders something to run with” and 2) The market ran with it even though “It took literally a couple of days for the market to fully understand” and 3) Paulson “did an admirable job” in cogently laying out his view. Sheesh. I will leave this to the reader to sort out the various contradictions in those statements.

Let’s now turn our focus on speculation as defined by the Commitments of Traders reports (COTs).

Commitments of Traders

For those unfamiliar with this frame of reference, commercial traders and noncommercial traders have to report their open interest in futures (in this case, currency futures) once a week. Those results are summarized in COT reports. A quick glance at any of the following charts will show noncommercial, commercial, and nonreportable positions.

Think of commercial traders as either producers or hedgers. In the case of something like gold or corn, the commercials will be the miners or the farmers. But they could also be jewelry makers or cereal makers like Kellogg’s. In short, the commercials represent someone wanting to hedge future costs from rising or producers wanting to lock in prices at which they can profitably produce. In the case of currencies, the commercials might be importers or exporters not wanting to take on currency risk. The commercials might also be big trading houses wanting to hedge exposure to various markets for one reason or another. Commercials are thus hedgers.

Think of the noncommercials as the big hedge funds speculating one way or another (long or short) in a commodity or currency. The nonreportable positions would be a small trader speculating one way or another on currencies or commodities. Trading size determines reportability.

Using the COT Report

Investopedia offers advice on using the COT report:

“In using the COT report, commercial positioning is less relevant than noncommercial positioning because the majority of commercial currency trading is done in the spot currency market, so any commercial futures positions are highly unlikely to give an accurate representation of real market positioning. Noncommercial data, on the other hand, are more reliable, as they capture traders’ positions in a specific market.

“There are three primary premises on which to base trading with the COT data:

The COT reports come out on Friday as of the previous Tuesday. (This delay is nonsense in the current electronic age, but it is what it is.)

If you are still with me, following are a few snapshots from the most recent currency COT reports:

Yen

The above chart shows that the noncommercials (big speculators) are short 128,526 contracts in the yen (betting it will fall lower, or that if it rises, they can make more elsewhere). This is part (but likely only a small part) of the infamous carry trade (shorting the yen and investing elsewhere, typically U.S. Treasuries). Each contract represents 12,500,000 yen (as of this writing, $102,804 per contract). The total amount bet on interest rate differentials between the yen and the U.S. dollar as of the report date is $13,212,986,904.

The article on Paulson above made this statement: “The currency is near a 20-year low on a trade-weighted basis, and Commodity Futures Trading Commission figures on Feb. 2 showed a record 173,005 positions betting on a weaker yen.”

The COT charts in this blog were reported on Friday, Feb. 9, so we can see some unwinding of positions since then. Or can we? Notice I said reported on Feb. 9. They reflect positions as of Tuesday, Feb. 6. Just as with stock market short interest (reported only once a month), potentially useful information is kept from the small traders while others potentially know. This is not as bad as short interest in stocks, but there is no real excuse for it. We do not know the current position of the COTs.

At any rate, the carry trade in the yen will unwind at some point. It will not be to the benefit of the U.S. dollar when it happens. For more thoughts on this idea, please refer to “Mr. Practical on the Yen, Carry Trade, and Credit Expansion.”

One more point: An unwinding of the yen position will be yen supportive and dollar negative. That increases (but certainly does not negate) the likelihood that the trendline break in the yen as shown on the first chart is a fake one:

British Pound

A quick look at what the noncommercials are doing shows a chart that is about as lopsided as it gets. There seems to be mammoth one-sided speculation on the British pound versus the U.S. dollar.

62,500 pounds is currently $121,950, and the big specs are long 92,728 contracts, thus there is $11,308,179,600 bet on U.S. dollar versus British pound currency differentials. This will get unwound at some point, and in contrast to the yen, an unwinding of these contracts should be U.S. dollar supportive when it happens. Timing the reversal is, of course, the issue.

Canadian Dollar

For whatever reason, hedge funds are short 80,646 contracts on the Canadian dollar.

The unwinding of this trade would be supportive of the Canadian dollar and that similarity to the yen suggests a possibility that this is a potentially false breakdown.

Euro

Speculation on the euro is not as massive, nor is it as one-sided, as some of the others. However, small speculators (nonreportable positions) are substantially long (relative to small spec positions), with commercials net short 65,632 contracts and the big speculators long 45,330 contracts. The unwinding of those contracts would likely be supportive of the U.S. dollar. Each contract represents 125,000 euros (as of this writing, $162,562 per contract, or $7,368,935,460 total on 45,330 contracts). On the surface, this might not seem like such a big deal (at least as compared with the yen). But one must also look at the relative weighting of currencies within the U.S. dollar index, and that is where the rubber meets the road.

Relative Weightings

What is the U.S. dollar index?

• A widely recognized benchmark that reflects the value of the U.S. dollar on global markets
• A geometric average that tracks the value of the U.S. dollar against a basket of 6 currencies
• The USDX is based upon the original U.S. dollar index calculated by the Federal Reserve Bank, base year of 1973.

The following pie chart tells the story:

Weightings

What the Swedish krona is doing in the index, I haven’t a clue. But the key issue is that those expecting a huge rebound in the yen to sink the U.S. dollar index are likely barking up the wrong tree (at least from the standpoint of an unwinding of futures contracts). The yen is only 13.6% of the index, while Europe (the euro and pound) comprise 69.5% of the weighting, with the euro a whopping 57.6%.

This concludes Part I of Focus on Currencies. This is NOT a complete view. The carry trade in the currency markets (as opposed to the futures market) dwarfs the significance of the COT data according to some well respected economists. The message here is that it is easy (too easy) to focus on one or two aspects of a trade while missing the big picture. Tomorrow, I will attempt to fill in some of the rest of the picture with a focus on the carry trade, as well as a brief discussion on the fundamental factors that drive the relative valuations of currencies.

Regards,
Mike Shedlock ~ “Mish”

February 12, 2007

Focus on Currencies, Part I was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.