Bailouts Will Soon Drive the Currency Markets 17 comments
Nicholas Jones
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Oct. 13 (Bloomberg) – France, Germany, Spain, the Netherlands and Austria committed 1.3 trillion euros ($1.8 trillion) to guarantee bank loans and take stakes in lenders, racing to prevent the collapse of the financial system.
With this $1.8 trillion, and the most recent rumors of a $250 billion bank stake funded by the U.S. Treasury, G-7 economies will have flooded the global banking system with over $10 trillion worth of currency.
I’ve been a proclaimed dollar bear for some time, and this changes nothing except how we look at or define the title. Many consider a dollar bear market one where the value of the dollar declines relative to the other currencies. That is fine, and I wrote last week that changes in the value of a currency relative to another currency is simply the difference in the money supply growths of the two currencies, but financial markets are changing fast.
Bailouts Soon to Drive Currency Markets
Going forward, we will no longer be able to define the dollar’s weakness by its exchange rate with the Euro, Yen, or any other foreign currency. Instead, we have to look at their purchasing power relative to tangible assets. The exact reason is the quote from the Bloomberg article. This is a GLOBAL race to inflate, and the near term fundamental drivers of forex markets are as follows: the amount of short term debt liabilities that will need to be rolled over and leverage ratios of the countries banking system.
You see, governing bodies and monetary authorities have to guarantee their banking systems. They have no choice. Whether they do it Britain style with an all out guarantee on banking deposits (soon to be a 100% guarantee in the U.S.), or whether it’s simply nationalization of the banking system, governments will back up their financial systems. The alternative is simply not an option.
In order to guarantee and/or bailout a financial system, money must be created and injected into the banking system. By defining the amount of short term debt liabilities and banking system leverage ratios, we can define, more or less, how much money is going to need, relative to other nations, to be created in order to bail that nation out. This will be the ONE DRIVING FACTOR in forex markets for the next phase of this financial crisis.
Please don’t get me wrong. In the whole scheme of things, the dollar demise is still well in tact. The fundamental issues we facing the value of the U.S. dollar are still there, and in a way, unique to the U.S. dollar. These issues will be covered in future editions of B&B.
Bear Market Rallies Are Just That
This brings us right into the next issue. Throughout the systematic decline of equities markets, cash and government debt has been king. So much so, in fact, that U.S. treasuries were recording some of their lowest yields in history.
This is a trade that will DIE. I believe that the long bonds trade will explode, and getting short the bonds will be one of the greatest trading opportunities of our life time (along with long gold). I can tell you exactly how this scenario is going to play out.
Equities markets have, or are in the process of forming an interim bottom. This is not a bold claim as every analyst and their mothers have been claiming this for a week or more. I think I’ve actually heard the word capitulation more times in the last 7 days than I have in the rest of my life combined.
But contrary to what you hear on CNBC, this is not the end of the bear market, and this will not be the absolute bottom. Historically, bear markets last 12-14 years, not 12-14 months. What we must understand is that there are sizeable rallies in bear markets. The bear market that lasted from 1968-1982 had three rallies of 40% or more. We are about to experience one of those rallies.
Like in the 1970s, those rallies ended, and markets made new lows. WHEN, not if, that occurs here in the U.S., investors will be forced to make some decisions. Next time cash and bonds won’t be king.
The Golden Rule
You see, the same problems that will drive down our stock markets WILL RESULT IN HIGHER INTEREST RATES AND MASSIVE INFLATION. The ONLY direction for interest rates is higher. Please note that I’m not talking about official rates set by monetary authorities. They will be slashed to near zero levels, but the Fed will not be able to control our multi trillion dollar economy by manipulating short term interest rates.
With equities crashing, inflation running rampart, and interest rates going ballistic, investors will shun government debt, and I don’t care if it’s a 10- year U.S. bond, German Bund, or U.K. Guilt. Being short these markets at the right time will result in truly fantastic returns.
Reading between the lines here, the one market that will be left for investment will be commodities. Listen, for the last three years I’ve been saying there will be some notable events that will unleash commodities markets. The events are based on the notion of commodities like gold holding two main purposes: a dollar hedge and flight to safety.
The first of those events recently occurred. I’m referring to the collapse of the Euro. The Euro has been a prominent dollar hedge up until now. That will no longer hold as Trichet and his cohorts at the ECB began flooding their financial systems with liquidity. This resulted in individuals who hedged their dollar with Euros needing to find another option…got gold?
The second event, I’m sure you’ve figured out by now, has to do with gold’s substitutes as a flight to security. This is obviously the bonds and cash markets. When investors realize that bonds and cash are no longer a true flight to safety, we will see some real fireworks in the gold market. As previously mentioned, this will most likely occur during the next down turn of the equities markets. Please remember that the size of the bond market COMPLETELY DWARFS the precious metals market. These markets will have a hard time absorbing the liquidity and massive volatility will ensue.
What we are about to be faced with is the Golden Rule, but it’s not the rule you were taught growing up. My Golden Rule is very simple: he who has the gold rules. This was the very first thing my mentor ever told me. It has been true since the time of pharaohs, and will it will stand true long after we depart from this world.
Note: The author and publisher do not hold positions in the securities mentioned.
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This article has 17 comments:
Mark
editor@dgcmagazine.com
Are our leaders insane?
If,If, If....I feel bad to be the one to tell you, so just reread your own post. The dominos are already falling and there is no way that the fools that created this mess are smart enough to get us out of it.
It is really just that simple. You have two choices, the first is to put your full faith and credit (literally) in the hands of the criminals who created this mess or self preservation. You choose. There is not much time left.
go ahead pal, make a shitload of money, and then.. where are you going to spend it ?
in a psychiatric clinic ? because your daughter got raped and your son are on drugs ?
yeah , lets go! let us live in broken homes, a destroyed society, in pro of few with a lot of money, that dont know where and what to do with it.
When I say "if," I don't mean "when." I have a passle of TWM, SDS, GLD, and SLV that says I don't disagree with your prediction.
I do not agree, however, that the "fools that created this mess" are on Wall St or K Street. My first domino is the trade deficit. Given Jimmy Carter's failed attempt to wake us up from our addiction to oil, I believe that the relevant fools can be found in our bathroom mirrors. All of the mistakes of all of the subsequent fools were largely irrelevant to the big picture. Those latter fools determined which card would be pulled out of the house to trigger the collapse, but we built the house. But even if Government did not make this mess, Government may be the only one that can fix it, and pessimism about the ability of Government to get it right is certainly not without historical support.
On Oct 15 09:29 AM Kelly Lieberman wrote:
> Remarkl,
> If,If, If....I feel bad to be the one to tell you, so just reread
> your own post. The dominos are already falling and there is no way
> that the fools that created this mess are smart enough to get us
> out of it.
> It is really just that simple. You have two choices, the first is
> to put your full faith and credit (literally) in the hands of the
> criminals who created this mess or self preservation. You choose.
> There is not much time left.
I bet he hasn't a ounce of gold or silver in his safe! Those paper promises, oh well, I'm not going to beat that (very) dead horse!
Love your posts, Kelly. Of course, you know that!
On Oct 15 01:46 PM User 30121 wrote:
> Kelly, you tried. remarkl just doesn't get it. Granted, he/she has
> faith in the system, and we "should" have that, but let's face it,
> if you buy a dog for protection, and at every opportunity to excel
> in his job to protect you, he BITES YOU, what should you think/do?
>
>
> I bet he hasn't a ounce of gold or silver in his safe! Those paper
> promises, oh well, I'm not going to beat that (very) dead horse!
>
>
> Love your posts, Kelly. Of course, you know that!
Visit his blog at jimrogers-investments....
The dollar may be damaged by the discovery that the Reward Points we have been distributing to our trading partners cannot be redeemed for anything worth having, but that's not a result of the Treasury printing money so much as it is the result of exporters grasping that they will not in fact get paid for what they send us. (Of course, taking into account the low marginal cost of selling stuff to us, that risk may actually prove acceptable to them...)
On Oct 15 02:30 PM Pipo wrote:
> Jim Rogers is also worried abaout massive inflation going forward.
> Commodities will excel.
>
> Visit his blog at jimrogers-investments....
More so how do we protect ourselves.. what is your opinion??
One of the reasons that capitalism works (or would work, if there were a free market anywhere in the world) is that fools with more money than sense take stupid risks, lose their money, and are disarmed. Have a look at George Bush's experiences in business! Talk about redistribution of wealth! But if we prop up the same morons, we are just saying "you missed me! Take another shot!"
As for gold and silver investment, I use bulliondirect.com/, which allows me to buy it bit by bit over time, keep it in an account there, and have it shipped when I have big enough piles to minimize the cost. Right now, the silver/gold ratio is at 80:1, and historically it has generally hovered at 50:1, so it's a good time to buy some silver and trade it for gold when the time is right.
By the way ... on the short selling tirade above ... short selling is needed, because on the the most important functions of markets is to serve as a communication bus. Getting millions of opinions is a big help if you're trying to figure our what's going to happen. One of the ways this information is transmitted is through short sales, which allow people who were not silly enough to buy into an enterprise which is going to fail to communicate to others that they believe that it will fail.
I'll leave you with a quote from Hamlet:
Hamlet: Is not parchment made of sheep skins?
Horatio: Aye, my Lord, and calf skins, too.
Hamlet: They are sheep and calves who seek out assurance in that!
*** The moral of the story is do not put your faith in paper. A fiat dollar is worth a politician's promise: no more, and no less. I'll take gold and silver, thank you very much!
In the 50s through 70s, Bear markets had an average length of 12-24 months, the Economic Cycle was on average 4 years and Boom to bust was usually about 2 yrs.. This was when the US still had a robust Industrial Base and these cycles can easily be seen by Graphing the stock market during that time frame. They were Cyclical Bull/Bear markets. Secular Bear Markets like the one that was entered in 2001 can last far longer BUT one can have many Cyclical intrusions within the Secular Trend. The 1966 to 1982 Secular Bear had many such.
The Biggest difference between then and now is that the dissemination of knowledge about Global conditions is almost instantaneous. This compresses the time it takes to get the Bad News into the System.
The 2002-2003 Cyclical ended 12 months ago.