–This week’s episode of “The Welfare State in Crisis” features a guest appearance by the Emerald Isle, currently seeking about $110 billion in bailout money from the European Union. Actually, Ireland is not seeking that money, and that appears to be a part of the problem. The Irish government is content that it’s managing its problems well, independent of European meddling.
–But with 10-year Irish bond yields blowing out to a spread of 646 basis points over 10-year German debt last week, European officials are worried that problems in Ireland are problems for the Euro. And if problems for the Euro get worse, that means problems for Portugal and Spain too.
–No wonder the U.S. dollar quit falling last week. And no wonder commodities fell like a stone. Friday was an ugly day for commodities speculators. The CRB Index in New York fell 3.6%. Every single one of its 19 components was down. Sugar contracts fell 12% in London and corn and soybeans traded limit down.
–Part of the shocking action in commodities futures markets is the raising of margin requirements by exchanges. It happened in silver last week. And it happened for sugar too, when the ICE futures boosted margins on sugar contracts by 81% to shake out speculators. It will probably happen on gold futures too, and that might explains $40 thud last Friday, among other things.
–No one is forced to speculate, of course. But this is what the Bernanke Fed has wrought. Its Quantitative Easing action has put dollar owners in the position of doing nothing and losing money to inflation, or speculating in tangible assets that go up in price relative to the dollar. And it’s not just commodities. It’s currencies too.
–The G-20 summit in Seoul failed to produce any result on competitive currency devaluations. No one really expected it to. But what’s next? Since there is no quick and easy solution to replacing a broken world currency system, the slow, difficult, and ugly scenario must take place. It will probably be slow, difficult, and ugly.
–One thing you should expect more of is an escalating level of capital controls. Ironically, the first manifestation of this has been in export-oriented economies like Brazil, where the government tripled a tax on foreign investment in local bonds from 2% to 6%. It was designed to prevent further appreciation in Brazil’s currency, which yields over 10% and is up 35% in trade-weighted terms since last year.
–China, South Korea and other countries are taking similar measures. For big exporters, a stronger currency translates into a loss of competitiveness. And when capital markets are wide open and you find yourself on the receiving end of huge inflows, it can lead to rapid asset price appreciation and other forms of less desirable inflation.
–By the way, this shows you how everyone is complicit in trying to return to the status quo ante GFC. The export-driven BRIICs want to pretend that the credit-financed Welfare states don’t have real structural deficit and demographic issues that prevent a return to “normal” rates of consumption. They want the world be the way it was.
–Here in Australia, other than house prices being utterly unaffordable, it looks like things have never been better. The rising Aussie dollar (up 17% since the end of June alone) helps “contain” some of the inflation from booming coal and iron ore exports. That’s why the Reserve Bank of Australia is one of the only central banks in the world that does not appear to be actively trying to weaken its currency.
–Maybe the RBA agrees with Bloomberg that on a purchasing power parity basis, the Aussie is trading at a 30% premium to fair value. That makes it the most over-valued currency in the world at the moment. If it’s a short-term trade (instead of long-term or secular trend in which the Aussie surpasses the USD), the currency will weaken and not do any permanent damage to Australia’s own export competitiveness by making Aussie exports more expensive than alternatives from Africa.
–For now, the Aussie is the place everyone wants to be as well; a high-yield commodity currency from a country with comparatively low public sector debt (although high household debt), low unemployment, and economic growth correlated to Asia. What could possible go wrong when things can’t’ get any better?
–Speaking of Asia, the other non-Irish news that rocked commodity markets last week was that China again raised reserve requirements at key banks and may raise interest rates to ward off inflation being poured into China from the U.S. Stocks and commodities fell hard.
–What do you make of all this mess?
–To us, it means that anxiety about the Aussie being too strong for too long may be short-lived. China could be doing a dress-rehearsal for a much more dramatic fall in asset prices as the authorities try to prevent inflation from surging. This has obvious and bearish implications for commodity prices.
–If you look at the chart below, you can see there’s a pretty direct correlation between the ASX/200 and the CRB commodities index. If a weak euro and a tightening China mean a stronger USD, it means falling commodity prices and a falling ASX/200. The index is again trading right at Murray’s 4,700 point of control. That’s the level around which the price action has been revolving, according to Murray’s analysis.
(Click to enlarge)