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Wednesday November 26, 2008 - 16:33:53 GMT
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Dollar safe haven? Really!

Key News
• The move [Chinese interest rate cut] came just one day after the World Bank predicted that China would grow by 7.5pc next year. The level of growth may appear robust by Western standards, but it would represent the slowest economic expansion in China for the last two decades.  It is also perilously close to the 7pc minimum level of growth that Chinese economists believe is necessary in order to create enough jobs for the 6m university graduates who will enter the jobs market next year. (IHT)

US$ - Chinese yuan Daily:

(Chart unavailable in text format.)

"Fourth Law of Thermodynamics: If the probability of success is not almost one, then it is damn near zero”
     David Ellis

FX Trading – Dollar safe haven?  Really!
As every trader with some longevity knows the first question you should ask the moment a trade is made is this: Where am I wrong?  And that question needs to be repeated hundreds of times in your head throughout the trade in order to stay open to new information; that’s because your objectivity will always be ever so slightly tilted toward your current position.  After all you had to have enough confidence in your story to put on the trade in the first place…at least it had to be a 50.1% versus 49.9%!

We continue to look for reasons why we are wrong on our dollar story; there are many plausible ones out there.  But the excerpt from a recent Euromoney article titled, “The US treasury market reaches the breaking point,” sent to us form one of our very astute readers from the north, sums up a very good reason why the US dollar could be crushed and gold bugs could have it all dead right [our emphasis]:

“THE US TREASURY market, the foundation of government bond and corporate bond markets worldwide, is suffering a crisis of confidence at the worst possible moment. Investors in treasuries are the lenders enabling the US government bail-out of the country’s broken financial institutions. That leaves them financing purchases of equity of volatile and highly questionable worth and backing a ragbag of distressed assets. For now, treasury yields are at record lows across the term structure as investors with cash to invest conclude that they can trust no one else with their money. But investors must wonder at what point the expanded supply of government debt and its use will make the borrower inherently less creditworthy.

“There is an even more pressing concern for many participants in this increasingly swollen market: the settlement system has broken down. Following the collapse of Lehman Brothers in September, fails to deliver among the 17 primary dealers in the US treasury market have rocketed to more than $2 trillion over a period of weeks and still lie above $1.3 trillion. Broker/dealers have stopped delivering bonds. Holders of US treasuries are now scared to lend into the repo market in case their bonds are not returned, and potential buyers sit on the sidelines fearful of handing over their money to a counterparty that at best might not deliver a bond on time, and at worst might go under. 

“With global stock markets plummeting, investors are still turning to treasuries as a safe haven. But investors might become nervous if something is not done soon to sort out the market’s problems. ‘As yet investors are still coming in, but in the longer term the worry is the lack of functionality in the treasury market. That could impact investor perception on a longer-term basis,’ says Mike Pond, US treasury and inflation-linked strategist at Barclays Capital in New York. If investors turn their back on treasuries, the US government will find it increasingly difficult and expensive to raise money and roll over its maturing debts. Upward pressure on interest rates will occur at a time when the government needs to be loosening monetary policy in order to jump-start a domestic economy that is heading towards a depression.”

I guess the question is this: Where would money hide?  Maybe gold will be the only place to hide.  If so, that $2,000 number the gold bugs throw around could come into play. 

The reason this scenario, running from Treasuries has some plausibility is because this is a time when the implausible has become reality.  And the actions to deal with this crisis from our Treasury haven’t boosted anyone’s confidence in their ability to handle this mess.  But, despite that, it is still a bit inconceivable that real grownups out there would let this problem linger—the US Treasury market and US safe haven status is the gift that keeps giving for US fiscal policy that has been so flawed. And it is the cornerstone of safety globally.

People (institutions and countries) with large pools of capital have no other place to hide buy Treasuries.  And countries need to hold dollars in order to facilitate global trade.  If we take a breakdown in the treasury market to its logical and very scary conclusion, it might mean an end to the global monetary system, which means an end to trade and capital flow.  And that would trigger emerging/developing nation default everywhere, which in turn would crush European and UK banking, and major trading nations (Japan and China) who are dependent on the export model.  It would mean there would be no hiding place for money. 

This is the pull the cover over your head scenario. And it would likely give gold bugs exactly what they were looking for—gold $2,000 and beyond.  But you know what they say: Be careful what you wish for because it may come true.  A breakdown in the US treasury market means the gold bugs will win in the end, not because of the value of gold—no one will have any money to buy it nor will a functioning market or pricing system exist—but because they will have a lot more material than most to melt down into bullets for protection.

Reader Q&A:

Q: One event over the last week that has confused me is the current tight coupling of the GBP & EUR /USD Pairs. The pound began moving up and the EUR followed.

Before the EUR/USD followed the DJI futures almost point for pip. Now this has changed and the Pound is now playing the leader with DJI being the anchor.

In my opinion the current bullishness on the Pound will be short lived as pundits paint the walls that the pound is severely oversold and 140 is the lowest it will go. With that kind of information being touted traders and capital markets seem to be moving back into the pound.

To me this seems like a short lived phenomenon as GB dives into a massive deficit. Economic news and it's contraction in the financial sector seem like a parlor of mirrors that keep reflecting back the same news. Admittedly stabilization will provide some confidence along with tax cuts may induce spending but it's the same all over that spending has dropped and we seem to be in the savings cycle.

It would be great if you could explain why we are seeing this current rise in the pound with the EUR following.
A:  It is something we have noticed.  And maybe it is a function of the euro due to play some catch up on the bad news flowing into the price.  The pound broke in Nov ’07; the euro didn’t break against the dollar until July ’08.  For that reason, on a percentage basis, if the two pairs continue to fall against the dollar over time, as we expect, we believe the euro decline will be much faster.  The Eurozone has many countries and a lot of baggage to deal with.  The UK only has the UK.  Because of this, the euro seems exposed to many more negative surprises. 

(Chart unavailable in text format.) 


Jack Crooks
Black Swan Capital LLC


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