Monetary Policy

I have been sitting here watching the action on the US Dollar in the wake of Ben Bernanke's decision to keep the key interest rates at 2%.

With this decision, the US now joins the rest of the world in getting aboard the inflation fighting bandwagon. The past number of years have seen spectacular growth stories. Manufacturing has boomed in Asian and even here in the US growth was most evident in the housing market.

But growth has consequences and inflation is perhaps the greatest consequence. Now Central Bankers are on a mission to beat back the savage beast of inflation. Problem is, many Central Bankers started their mission against inflation many months back. Read more »

Watch interest rates around the world. We have come to the tipping point, the moment of reckoning where the savage beast inflation must be beaten into submission.

A meeting of finance types this past weekend in Kuala Lumpur, Malaysia concluded that the savage forces of inflation could derail the "Cinderalla-like" growth story that has charmed Asia for the past number of years. For example, inflation in Vietnam is running at a torrid 25%. Other Asian nations have now lifted subsidies on petrol, sending prices (and de facto, inflation) at the pump up 40% in some cases.

I can recall a speaker at a dinner event I attended back in 2005 making the bold statement that all would be well until such time as the Beijing Olympics were finished and then everything would come off the rails in Asia. Wow!! – he might just be right. As interest rates rise and bank lending tightens, the economy will slow notably in many of these Asian nations. And it is not just Asia. Look at what is happening in Iceland as it totters on the brink. Jean Claude Trichet in the Eurozone is now hinting strongly that maybe rates will start to ratchet higher. Even in Canada, finance officials are openly suggesting that the banking system should stop giving out mortgages amortized over 40 years and that there should be a ban on people borrowing their down-payment for a house purchase. Read more »

Currency traders – take note. This week the Bank of Canada was fully expected to cut its key interest rate another 25 bps. But….surprise, surprise. The Bank of Canada opted to leave rates unchanged so as to grapple with the inflation monster. This marks a major turning point in Canada. Central Bankers have been openly worrying about getting drawn into a US economic slowdown. But now all of a sudden the concern shifts to inflation. I say the global economy is at a critical turning point. Inflationary concerns will see rates move higher over the coming year in Canada and in other countries too.

For people like me who sell PUT Options on Currency Futures to earn extra money this week's policy shift is good news. A shift in stance on interest rate policy should underpin the Canadian Dollar. This week I was a seller of the Canadian Dollar July 95 cent Put Options. I brought in $160 per contract and I now have 3 weeks to go until expiry. Read more »

In a recent blog I compared the US Dollar to a "drunken sailor". In my most recent Commodity Supercycle Report I presented empirical evidence for a bear market rally in the Dollar. Evidence included an over-bought Euro, an over-extended Yen, and a Gold market in need of a correction.

It now looks like the "drunken sailor" is getting up. The Dollar is in fact attempting a rally and at issue is the glimmer of hope that the US markets were afforded recently. Bear Stearns fell on its sword and J.P. Morgan with the aid of the Fed deftly swooped in to collect the corpse. The Chairman of UBS stepped aside this week amid jeers and cat calls from disgruntled shareholders. UBS is now saying it is getting back to banking basics. Lehman Brothers went to the street looking for a $3 billion injection and came away with $4 billion. The markets indeed may be seeing some light at the end of the tunnel. Read more »

Imagine that during a particularly strong bull market you successfully trade the markets aggressively and you create a fortune of $10 million for yourself. Then the markets turn ugly and you lose it all. You then write a theory to explain why you lost it all. Sound far fetched? Well, interestingly enough, this actually did happen....

...to a Yale Professor of Economics called Irving Fisher. Interestingly enough, MBA level Economics classes today are very quick to talk about Keynes and Friedman, yet they steer clear of any mention of Irving Fisher. My CFA level 2 studies did advance an interest rate/inflation theory called the International Fisher Relation, but little mention was made of who this Fisher person was. Read more »

In a recent report, I wrote of how China was experiencing severe problems as a result of having its currency pegged to a basket of foreign currencies largely dominated by the US Dollar.

This week I find myself in San Francisco at the Hard Assets Conference. After a quirky breakfast at Lori’s Diner - a 1950’s styled eatery, I brought myself back to reality with a short walk uphill (is everything uphill in this town?) to Borders bookstore where I bought the Financial Times Weekend Edition.

A chart buried on page 18 caught my caffeine-heightened attention and I have re-produced this chart for you above. Arab Gulf nations like Saudi Arabia, Kuwait, Bahrain, Qatar, UAE, and Oman have all pegged their currency to the US Dollar. And rightly so, given the oil trade that these nations conduct in US Dollars. Problem is, if I peg my currency to yours, I have to follow your Money Supply policies. If you ramp your money supply up in an unbridled fashion, then I must do likewise. Read more »

Since August we have been overwhelmed with nothing but bad news from the sub-prime mortgage front and from the global liquidity arena. The news and events since August have been almost enough to make people admit defeat. And that is precisely the discussion I had with a gentleman from Wachovia Securities whilst in Cancun recently at the FAMMS Conference.

The terminology we bantered about was the phrase “liquidity trap”. A liquidity trap tends to occur in an economy when financial intermediaries are not willing to lend to each other. Consumers scale back their spending even though interest rates remain favorable. Financial markets tend to then suffer (just ask the Japanese who endured a decade long liquidity trap). And a liquidity trap is precisley what we may be facing now.

Banks are sitting with off-balance sheet assets (the true extent of the SIV's still is unclear) and the economy is waiting for the “other shoe to drop” as it were. Consumers are starting to scale back in the face of a weakening housing market and the financial markets are up one day and down the next as uncertainty prevails. A recent report on BBC even suggested that 34% of sub-prime mortgages are going into default in the USA. Read more »

There once was a banker who enjoyed tremendous success lending to clients around the globe. But gradually over time, the forces of globalization grew so powerful that his clients no longer needed to borrow from him for they were enjoying unprecedented wealth of their own.

If you are waiting for Snow White and some dwarves to come around the corner next, forget it. This is no fairly tale. This is real.

The banker I speak of is the International Monetary Fund (IMF). Once a powerful global lender to developing nations, the IMF now has only $20 Billion in outstanding loans ( 1/4 of what it had 7 years ago)and half of this outstanding amount is to one country - Turkey. Read more »

This past week at the Prospector's & Developers Conference in Toronto, Canada I had some interesting talks with other newsletter writers and our conversations gravitated to the notion of “twin shocks”.

It was generally agreed that at any given time, the economy can handle one shock, be it a Mexico peso crisis, a Russian ruble crisis, a tech bubble, 9-11 attacks and so on. But, we now have "twin shocks" facing the economy and the economy is struggling.

We are facing 1970’s style commodity inflation as the first shock. The easy to get at resources have been found and have been (or are being) exploited. The world’s arable lands are stretched to the limit yet we keep pouring fertilizer on them and demanding that Nature produce more bushels of Corn, Wheat and Beans. The monetary liquidity flooding into the system is making more dollars available to chase these commodities and higher prices are the result. Efforts to use these grain products to produce bio-fuels are not helping either. The economy is straining under the load and the term stagflation is coming into vogue again. Read more »