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Wednesday November 21, 2007 - 13:01:45 GMT
Black Swan Capital -

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“Anything that happens to money to debase it, to degrade it in relation to the total sum of wealth, so as to impair its buying power, is something that happens to people who have loaned their labor to the banks.
“Why do we confine the function of money issue to the government, and have very rigid laws concerning the exercise of that function by government, and make counterfeiting illegal?  All that is with the idea of keeping the value of money constant, for if money is permitted to increase faster than the wealth of things which we price in money, then the value of labor saved in the form of money will deteriorate like a cord of wood in the weather.  When for any reason a government is moved to embrace legal counterfeiting, when it begins to issue spurious money—money that has no definite relation to any form of wealth in being or in process—the sequel is well known.  There is a progressive inflation, which, once it begins, there is no stopping or controlling, short of the final disaster.  At the end, the savings of a lifetime, reconverted into money, may not be enough to buy a hat.
“This we have learned about money itself, dimly.  We have yet to learn it about credit, even dimly.”
     Garet Garret, The Bubble that Broke the World (1932)
FX Trading – UUT OH! 

Is this thing about to get away from our seemingly omnipotent central bankers? 

In other words: Paper here, paper there, and we still have a credit problem.

The key stat that sticks in our mind, for some reason, is this:

On Dec. 31st 2006 the total nominal value of derivatives was 7.9 times LARGER than global GDP. 

Dwell on that size for a moment.  Then dwell on the incredible complexity of some recently manufactured derivatives for a moment.  Then think about how globalization has so tightly interlinked every major capital market across the globe.  Then, go into the backyard and start burying the cans.

Just kidding on that can part.

But, one wonders how much longer the central banks can keep the music playing.  It’s becoming harder to hear those old tunes over the sound of bombs exploding inside the balance sheets of our elite financial institutions.  It’s now dawning on their bomb demolition teams, once known as risk management committees, that much of the money and faith they poured into “stress-testing” of exotic portfolio concoctions was all for naught.  The real world keeps getting in the way. 

We wake this morning to risk aversion (scramble for some cash).  Who knows what tomorrow will bring.  We seem to be ebbing and flowing from one theme to another by the day.   

But even on that score, we have noticed a changing of the guard.  It used to be the yen would consistently weaken during the risk appetite times i.e. move counter to the pack of currencies relative to the dollar.  E.G. if euro and commodity dollars were higher, then the yen would be lower.  That dynamic has changed.  We think it says the carry trade game is dead for this cycle.

The carry trade genie is out of the bottle, so to speak.  If the central bank papering of the credit crunch to date has not done the job, it’s unlikely the institutions with said bombs on balance sheets, who once were primary participants in said carry trade perpetuation, will continue to play that game.  Especially now that the yen looks headed for glory i.e. 100 USDJPY has been our broken-clock prediction for some time (longer than we care to admit).

The point is this: If the central banks lose control here, and they can’t pump out enough paper to cover these problems, the theory of global decoupling will be falsified quickly. And 100 USDJPY may look conservative.  As impressive as the size of reserves held in Asia, the Gulf, and Russia appear, they pale in comparison to complex credit instruments in the market still ticking away. 

And remember, it’s the stuff at the margin that matters when one is leveraged to the gunnels, as the world is now.  It takes and increasingly larger amount of new credit to provide the same relative stimulus at the later stages of the boom.  And with credit markets quite possibly shifting into reverse gear, the magnitude of the bust could be amplified. 

Be careful out there!

Jack Crooks
Black Swan Capital


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