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No Matter What Tim Says…

jhaddock (March 30, 2009)

Issue #51: Monday, March 30, 2009

We’re Still Headed for Inflation

Also In Today’s Letter…

By Chris Gaffney Chuck’s still traveling this week, so he asked me to fill in while he’s away.

Honestly, I can’t believe March is nearly over. It seems as though it just started, didn’t it? March will end up being a pretty good month for the currency markets. Over the last few weeks, investors have finally started to move away from U.S. Treasuries and are moving funds back into higher yielding assets.

But the markets are still volatile, and news released on Friday and over the weekend has sent these investors rushing back to the safe haven of the U.S. dollar once again.

Traders rushed for the yen and buck after a U.S. Government official said Friday that bankruptcy may be the best option for GM and Chrysler. The dollar continued to gain strength this morning after U.S. Treasury Secretary Geithner warned yesterday that some financial institutions will need “large amounts” of aid.

When the Treasury Secretary mentions “large amounts,” you know it is going to be billions or trillions! Geithner was making the rounds on Sunday morning talk shows to try and justify the money already spent and prepare the taxpayers for another request for funds.

The Japanese yen certainly benefited from the safe haven buying. In fact, the yen turned in the only positive performance versus the buck. Japan, which indicated a cut in inventories, added to the yen’s good day. Inventories fell 4.2% last month, and companies said they would increase production in coming months. That indicates the worst of the manufacturing slump may be over.

But with exports falling, and retail sales tumbling, I don’t expect manufacturing to pick up anytime soon. Deflation continues to be a problem in Japan, as consumer prices remain stalled. With benchmark rates as close to zero as possible, the Bank of Japan has little ammunition left to combat the falling prices.

In other words, if you still own the Japanese yen, take advantage of these small rallies to exit your position because the yen will probably not be able to maintain this strength.

Is Quantitative Easing Coming for the Euro Too?

News from Europe fed into the dollar’s strength as a report showed industrial orders plunged 34% in January, the most on record. Another report showed France’s economy shrank by 1.1% in the fourth quarter, the steepest decline since 1974.

www.bloomberg.com

With all of this negative data, it isn’t hard to see why European confidence fell to the lowest on record in March. An index of executive and consumer sentiment in the euro region released this morning fell to a record low.

All of this negative data is boosting calls for further rate cuts by the ECB. After the 50 basis point cut at the beginning of March, most currency traders expected the ECB to pause and hold rates steady for a couple of meetings. But now they’re starting to call for further cuts…and they’re getting louder by the day.

The euro had the worst day vs. the U.S. dollar in nearly three months on Friday. The anti-dollar is now holding just above 1.32. Some are now even suggesting the ECB follow the U.S. and U.K. down the path of “quantitative easing,” buying bonds to pump more money directly into their economy. This is one of the most inflationary moves a central bank can take, and would be a dramatic step by the typically hawkish ECB.

Someone Else Thinks All This Is a Bad Idea

But not everyone in Europe wants the ECB to follow the paths of the U.S., U.K., and Japanese central banks. Germany’s leader, Chancellor Angela Merkel warned against inflating the global economy to revive growth.

Merkel just rejected calls to spend more public money in Germany to speed the recovery. “This crisis did not come about because we issued too little money but because we created economic growth with too much money, and it was not sustainable growth,” Merkel said, according to the Financial Times. “If we want to learn from that, the answer is not to repeat the mistakes of the past.”

Merkel’s position is in stark contrast to our own administration, who have taken a somewhat shortsighted “grow now, worry about inflation later” stance. In fact, the U.S. administration is excited about how they have been able to manufacture a new “refinance” boom by forcing mortgage rates back down.

But personally, I’m with Merkel on this one. After all how will policymakers unwind all of this “easy money” once the recovery begins?

“This is NOT Going to Lead to Hyperinflation?” Come On Tim.

Does anyone think the Fed will have the courage to end their emergency-lending programs while the unemployment rate remains near double-digits? I don’t.

You know the administration is going to push the Fed to wait until there are clear signs the U.S. is in recovery before moving rates back up. But any slight hesitation on the Fed’s part will spark inflation. And that inflation could quickly grow out of control if left unchecked.

But Treasury Secretary Geithner said yesterday that the Fed’s injections of reserves into the economy are, “not going to create the risk of hyperinflation in the future.”

“We have a strong independent Federal Reserve with a very strong mandate from the Congress, and they will do what’s necessary to keep inflation low and stable over time,” Geithner said on ABC’s Meet the Press. At the same time, he warned policymakers shouldn’t, “put the brakes on too quickly.”

I hate to disagree with the Treasury Secretary (ok, you caught me, I actually kind of like disagreeing with the Treasury Secretary) but I just don’t think they have the ability to keep inflation at bay.

The Fed has injected record amounts of liquidity into the system, using some untested “‘quantitative easing’ “procedures which will need to be reversed. With the Fed pledging to purchase another US$1.25 trillion of mortgage debt and US$300 billion of Treasuries, inflation is inevitable.

That’s it for today…Chuck’s still globetrotting around Florida all this week, so I’ll be back tomorrow with more updates on the overnight markets. Till then…

Hope everyone has a Marvelous Monday!
Chris Gaffney, CFA
Vice President, EverBank World Markets

EDITOR’S NOTE: Next month, Chuck will join investment and asset protection experts from all over the world for The Sovereign Society’s huge “superbowl” event of year, the Total Wealth Symposium in Bermuda April 26-29. . In just four days, these pioneers in finance will teach you…how to use dividends to recoup your losses from 2008…how the pros use foreign currencies to pad their portfolios…how to rebuild your retirement plan – and then shield it so you can never lose it in a legal battle… three revolutionary techniques the world’s wealthiest use to safeguard their assets…and so much more. Interested? Click here to get all the details. Plus, register by midnight tonight and claim US$812 of FREE gifts.

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