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Tuesday August 7, 2007 - 10:54:16 GMT
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Problems at the center can send “stuff” south in a jiffy!

Key News


Crude oil fell, taking its losses to more than 6 percent over three days. (Bloomberg)



Key Reports Due (WSJ):

7:45a.m. ICSC Chain Store Sales. Previous: +1.1%.

8:30a.m. 2Q Preliminary Productivity. Expected: +2.0%. Previous: +1.0%.

8:30a.m. 2Q Preliminary Unit Labor Costs. Expected: +1.8%. Previous: +1.8%.

8:55a.m.Redbook Retail Sales Index. Previous: +0.5%.

3:00p.m. June Consumer Credit. Expected: +5.9B. Previous: +$12.9B.

5:00p.m. ABC/Wash Post Consumer Confidence. Previous: -8.



“Several excuses are always less convincing than one.”


                        Aldous Huxley


FX Trading –  Problems at the center can send “stuff” south in a jiffy!


Remember the “deflationary pumps” in the background idea we threw on the table about two weeks ago to help explain why 100’s of trillions of dollars worth of derivatives manufacturing i.e. liquidity creation, hasn’t morphed into severe global inflation? 


Crude is backing off fast on global growth concerns—6% in the last three days.  The question is:  If the subprime problem is only a US problem and if the world has “decoupled,” as many new paradigm seers suggest, why should there be any concern about demand? 


Our guess:  Precisely because of derivatives financial markets are very closely “coupled” and a decline in financial markets represents a decline in collateral values and collateral values are the transmission link to the real economy, which is global demand. A local “US problem” is spreading globally i.e. contagion, because the US is still at the center of the financial universe.


If our guess is right, than our perverse dollar rally scenario caused by US bad news is still operative.  Money at the periphery will sooner or later come home to roost. 


“By definition, the center is the provider of capital, the periphery the recipient. An abrupt change in the willingness of the center to provide capital to the periphery can cause great disruption in the recipient countries.  The nature of the disruption depends on the form in which capital was provided.  If it was in the form of debt instruments or bank credits, it can cause bankruptcies and a banking crisis…,” write George Soros.  [our emphasis]



Already we are seeing a “banking crisis” at the center in the form of Bear Stearns. [Germany saved one of their banks last week.]  How many of us would have believe just a month ago that rumors of Bear facing a liquidity crisis would surface in this idyllic cycle of credit that was supposed to evenly parcel risk thanks to packaged derivative products?  It goes to show how quickly things can change near the end of a long business cycle that’s driven by a chain of credit. 


The marginal economic stimulation from each dollar of credit declines near the end of the cycle.  And as this credit growth explodes quietly behind the scenes to provide this declining marginal stimulation, real people in the real economy only see a relative increase in growth.  Thus, they are surprised to learn there is a ticking time bomb of credit supporting the collateral behind said growth.  It becomes all too apparent when a major financial accident (Bear might just do it) leads to the a decline in real economic growth.    


A credit crunch transmits an extremely deflationary impact into the real economy because it leads to a swift decline in collateral values that support real demand for real stuff, like crude oil (and gold?).  “Stuff” that once looked like the thing to own during the credit boom (because of “inflation concerns”) turns south in a jiffy and surprises.


You probably already know that crude and the dollar have been fairly closely negatively correlated of late, but in case you didn’t, the chart below shows exactly that (as crude rises the buck falls, as crude falls the buck rises)…maybe?








And just for kicks, the chart below shows crude oil vs. gold on a daily basis…






It appears that “stuff” has been moving along the same path nicely!  Hmmm….


Jack Crooks

Black Swan Capital



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