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Wednesday February 27, 2008 - 12:42:11 GMT
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Risk appetite back, or is it something else

FX Trading – Risk appetite back, or is it something else

Well, it looks like they did it!  One has to marvel at the power of money, pumped out by central banks and governments, and its ability to stoke the flames of risk taking.  At least for now, confidence in global growth and demand appear restored.

It seems the quintessential Risk Appetite trade is back:

• Buy stocks
• Buy commodities
• Sell the dollar with both feet

The dollar is getting smoked, in case you hadn’t noticed.  It was a wholesale-type move yesterday, evidenced by all the major currencies running higher against the battered buck.  And today isn’t shaping up much better for the world reserve currency (we like to use that term while we still have time).  Back into a fresh all-time new low territory on the US dollar index we are…

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The stunning part of all this is the move in commodities prices—all are moving higher now at the same time, including industrial metals, energy, and food. 

Thinking about the move in commodities, a couple of thoughts pop in:

1. Commodities are the best investment class alternative on the belief that Asian demand will continue even if the West slows.
2. Soaring inflation expectations mean hard assets are the place to be. 

Needless to say, category number two is where the real danger comes into play.  This represents the “careful what you wish for Mr. Policy Maker as you may have juiced Mr. Market beyond repair.” 

No one summarizes the inherent danger of credit expansion (now the full-time job of central banks and governments in the West) better than the late great Austrian School economist Ludwig von Mises.

“Sooner or later, credit expansion, through the creation of additional fiduciary, must come to a standstill. Even if the banks wanted to, they could not carry on this policy indefinitely, not even if they were being forced to do so by the strongest pressure from outside.  The continuing increase in the quantity of fiduciary media leads to continual price increases.  Inflation can continue only so long as the opinion persists that it will stop in the foreseeable future.  However, once the conviction gains a foothold that the inflation will not come to a halt, then a panic breaks out.  In evaluating money and commodities, the public takes anticipated price increases into account in advance.  As a consequence, prices race erratically upward out of all bounds.  People turn away from using money which is comprised by the increase in fiduciary media.  They ‘flee’ to foreign money, metal bars, ‘real values,’ barter.  In short, the currency breaks down.”

I don’t think we have reached panic stage.  But, we seem to be heading down the path that Mr. von Mises so eloquently defines.  Besides his brilliant understanding of the subjective nature of market valuation, the credit cycle, and human nature, Mises experienced hyperinflation during the Weimar Republic years.

Of course hyperinflation is not the only near-term path.  A very good case we think can be made for global deflation.  With headline inflation and commodity prices roaring higher, it’s a difficult for many to consider how quickly the current environment could morph into a deflationary environment.  The trigger would be a worldwide repudiation of debt, and likely accompanied by some type of dislocation on the “free trade” front.

Our policymakers seem to have made it clear they prefer inflation to deflation—always politically more palatable, with the huge caveat that said inflation is “controlled.”  And as we’ve said before, controlling Mr. Market, in a world where massive amounts of capital can cross boarders in a keystroke, makes herding cats look like kindergarten. 

Jack Crooks
Black Swan Capital


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