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Global equity markets rallied yesterday and earlier today after Thailand reversed its stand on imposing strict new regulations on the Baht that had been taken to try to stabilize their currency. The abrupt reversal was a reactionary move to try to stabilize the sudden and sharp currency move in the opposite direction. Currency markets are nervous.

The initial move by the Thai monetary authorities immediately led to a currency crisis in South East Asia, threatening to become a global crisis. The hope now is that the global currency imbalance that hangs like an executioner’s sword over the neck of capital markets can be resolved slowly through natural market forces.

That's not likely to happen.

What I believe happened immediately after the first Thai move is that the Bank of Japan intervened by selling Yen and buying USD, which stemmed the plunge of the USD. That was done to help Japan’s manufacturers that export to China and the U.S. But that strategy of the BoJ did not resolve the spending and debt crisis of the U.S., and the central bank sell-off of USD by countries like Iran, Venezuela and the like. So the Japanese remedy is too little, too late. There will soon be another currency crisis (or several other crises) in any country that relies too heavily on a strong USD.

As the USD was plunging over the past couple months, I observed major shifts of money flow occurring in global capital markets. I have been stunned by the rapidity of the money flow. This is “hot” money as the world has never seen it.

In the past few days as equity indexes have been hitting new cycle highs, and all-time highs in some cases, I have come to a belief that the equity market is not rising on a wall of worry but on the losses of hedge funds and traders who are short. They are being squeezed like Amaranth.

In the big picture, as I see it, the $USD will continue to fall (except maybe against the Yen, where sooner or later require higher interest rates by the Bank of Japan), and precious metals will rise as central banks continue to reflate to try to protect the fall of the USD, and to push their own currencies down in order to protect their own tourism and manufacturing.

So the Thai crisis avoidance did not solve a single thing other than delay the inevitable.

Yes, I have come to the belief that the major issue in global capital markets is not one of inflation or deflation, but currency imbalances and international trade. The administrations of other nations have collectively determined that if the USD falls too low, there would be a burden of cost to the American consumer that could no longer be carried, and these countries, as you know, rely on the U.S. consumer.

I think markets will only truly revert to normal after the next spike in gold -- something like we saw in the 1970’s, where currency imbalances had to be dealt with (and gold spiked), which led to a series of Bear markets (1973-4, 1978, and 1981-2).

At this point, traders can expect a growing number of analyst downgrades and fewer numbers of upgrades because objective analysts on Wall Street can no longer ignore the fact that debt (public and private) is being created faster than wealth (ie, the increase of real enterprise value).

Some of the upgrades I see today – Merrill Lynch’s upgrade of Citigroup after C had already increased in price by about +15 pct in six months. By this measure, would they re-iterate a Buy on General Electric after GE was pumped almost +7 pct (between $25 and $30 billion in market cap) in just 14 consecutive session hours last Thursday, Friday and the open on Monday?

Traders and maybe bankers are taking their eye off the ball. The issue is our ability to service debt, not the price of the collateral we are holding today.

The same thing happened last year with speculators in the U.S. housing market. People with no financial resources were buying multiple housing units in hopes they could, with minimum fix-up, flip the properties or huge price gains. For a while the prices escalated because of debt-created money flowing into that market. Then the investors realized that a suitable economic return (ie, cash coming in versus cash committed) wasn’t happening. Sure, the housing market thrived as long as investors were prepared to accept returns of 2 pct! For a while, that is. Then they saw that the prices were not still rising, but the taxes and maintenance costs still had to be paid. So they tried to sell. The only thing that gave them a reprieve this cycle (unlike other real estate cycles like 1990) was that the Fed continued pumping money into the system to keep interest rates from rising. Eventually it was high oil prices that sunk that market.

Yesterday I noted in this space that “volatility has been introduced into this market, (i) partly because of over-bought equities (where share prices are growing at an alarmingly fast rate compared to Free Cash Flow of the underlying companies), (ii) partly because of a global currency imbalance, and (iii) partly because of economic and credit bubble pressures.”

Nothing changed in a day because the Thai central bank reversed its position. They had taken action because the country needed it, and now they are reacting to the global interest, which was slapping them for trying to put the brakes on the growth of money. I think Thailand had it right, and the rest of the world will soon discover that the world cannot continue to print money and increase debt. What governments, corporations and individuals need to do now is to reduce debt, and build financial resources for an aging society that will not have the income to support itself.

Rising costs of housing, home insurance, energy, fuel for the car, healthcare and so forth will soon be impossible for the retired to meet. I saw it on the faces of the Florida retirees during the CNN series last week called War on the Middle Class.

Yesterday, the market tried to shrug off the rising costs of the U.S. Producer Price Index. A couple days ago it shrugged off the nation’s international trade deficit. Ignorance will not keep equity markets rising forever. Just as I did in 2H1999 and 1H2000, I am simply putting the writing on the wall. Traders who are shrugging it off must not have heard of the Greater Fool Theory.

Yesterday in the U.S. equity market, the Dow and Nasdaq started weak, gained strength and later closed weak. There were inflation worries after the PPI data was reviewed and considered. The Gainers List is chock full of my favorites: KRY, SLW, GFI, etc. Precious Metals did jump as I had expected, and so did Crude Oil (the Cdn oilsands plus CVX and XOM) and Coal. Gold was up +1.2 pct and silver up +2.3 pct. The Consumer Discretionary sector was weak again for the third straight day after a batch of bad economic data and negative guidance from companies like Circuit City (CC) (-18 pct ON THE DAY) and Hovanian (HOV -2.6 pct). ICSC and Redbook Research reporting soft holiday sales. Retailers (RLX) dropped -1.2 pct. The Tech sector (especially anything to do with TV sets and communications and programmable logic) was soft, such as LLTC, MXIM, BRCM, TXN, ALTR and XLNX. Software giant Oracle (ORCL), which had run up without explanation (as I continuously pointed out my concerns), sold off in huge volume to a tree-month low after reporting an in-line (ex-items) EPS number. Micron Technology (MU) also sold off (-1.9 pct) on large volume. Biotech is also under pressure. So, yes, a couple stocks, many at the heart of the U.S. military-industry complex, like BA and GE, may be holding your interest, but the writing is on the wall. This is not the time to be buying the dips. It’s time to let this market sag.

That may not be obvious as the charts of international equity markets are full of green arrows today, and the headlines scream of new record highs. But you ought to be concerned nonetheless.

Source: Global Markets: Currency Imbalances and Trade Are Driving Forces