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Wednesday April 8, 2009 - 13:18:04 GMT
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The dollar’s Achilles Heel?

Key News
• German exports fell for a fifth month running in February, and imports slumped. (Reuters)
• [Chinese] exports in February fell 25.7 percent from a year earlier. Economists polled by Reuters expect a 21.5 percent fall in March. (Reuters)
• Ireland’s Finance Minister Brian Lenihan said the country doesn’t need any bailout from the European Union and that he will continue to cut spending to control a ballooning deficit. (Bloomberg)
• For the first time in nearly 30 years, there are more people selling gold jewellery as scrap than buying new items.
Key Reports Due (WSJ):
7:00 a.m. MBA Mortgage Application Refinance Index: Previous: +3.7%.
10:00 a.m. Jan Wholesale Trade: Expected: -0.8%. Previous: -0.7%.
10:30 a.m. U.S. Energy Dept Oil Inventories
2:00 p.m. Mar Federal Reserve FOMC Minutes

The twentieth century, Mr. Murray suggests, represented the “adolescence” of mankind…

“Nineteenth-century science, from Darwin to Freud, offered a series of body blows to ways of thinking about human beings and human lives that had prevailed since the dawn of civilization. Humans, just like adolescents, were deprived of some of the comforting simplicities of childhood and exposed to more complex knowledge about the world. And twentieth-century intellectuals reacted precisely the way that adolescents react when they think they have discovered Mom and Dad are hopelessly out of date. They think that the grown-ups are wrong about everything. In the case of twentieth-century intellectuals, it was as if they thought that if Darwin was right about evolution, then Aquinas is no longer worth reading; that if Freud was right about the unconscious mind, the Nicomachean Ethics had nothing to teach us.

“The nice thing about adolescence is that it is temporary, and, when it passes, people discover that their parents were smarter than they thought. I think that may be happening with the advent of the new century, as postmodernist answers to solemn questions about human existence start to wear thin—we’re growing out of adolescence. The kinds of scientific advances in understanding human nature are going to accelerate that process. All of us who deal in social policy will be thinking less like adolescents, entranced with the most titillating new idea, and thinking more like grown-ups.”

    Charles Murray, quoted in The New Criterion April 2009

FX Trading – The dollar’s Achilles Heel?
If you have been reading our daily missives you probably know that we’ve dubbed the problems in central and eastern Europe as the Achilles Heel for the euro as these problems can easily be transmitted into big trouble for European banking.  But we haven’t spiked out an Achilles Heel for the US dollar (silver bullet so to speak), though we know it’s there.  Maybe the growing woes facing US state and local pensions represent it.  Here is a scenario, we’re not sure how plausible any of it really is, but thinking about this stuff we think helps no matter your position.

The potential ticking time bomb is the massive US state and local pension funding problem highlighted on the front page of the Financial Times this morning.  Why this the Achilles Heel for the dollar?  Because it could eat away at the domestic pool of US savings we expected to materialize.

Within our global rebalancing theme, the surge in US consumer savings dramatically increases the available pool of domestic capital.  But, if future pension payments to retirees are cut, this pool of savings will be much smaller than we otherwise expected.  The upshot, the write down of private debt could be overwhelmed by the issuance of public debt (US government as it federalizes state and local obligations) in a big way.  Thus, US dollar-based credit, of course fabricated from printing presses, increases dollar supply.  And it could dovetail very much with a big fall in dollar demand from Asia.

The reason we haven’t been as concerned as others about this “China nuclear option” is because we believed the rising pool of US domestic capital would more than offset the potential loss from China—the pension problem is another element of threat to that story.

If China starts liquidating US paper in an effort to get REALLY serious about propping up domestic demand (Japan and others might follow that lead), then it likely won’t be good for the greenback, to say the least.  For this to happen, China has to make the calculation that the loss of the US consumer will be replaced by China’s domestic one.  For if China cuts and runs, the impact on the US consumer will likely be felt through tightening credit conditions—again. 

Of course, China has to be very sure massive domestic stimulus will work very quickly.  For if it cuts from the US consumer and stimulus doesn’t work, already rising social tensions will likely spin out of control.  And of course we are back to the same game—pools of capital all across Asia run for a hiding place.  And despite all the warts, the dollar may be the only place deep enough to hide in this game of a perpetual ugly contest we call currency trading.

No matter what we’re told about “green shoots” and all that stuff, it continues to look increasingly dicey in the real world we live and read about.

Jack Crooks
Black Swan Capital LLC


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