Back where we started

As concern grows for the future of the dollar, we should reinterpret stock movements to take account of currency exchange fluctuations. The above chart shows the Dow since the start of the year (red line) and adjusted for relative value of the US dollar against the Euro (green line).

If you have any suggestions as to what other currency to use instead, I'd be glad to read them. I fear that future weakening of the British pound and the US dollar may well undermine apparent future recoveries on their stock exchanges.

Euro and EU doomed?

Justice Litle thinks so.

Beg to differ on one point:

If the Brown government fails, Britain will be left rudderless in the midst of the worst fiscal storm in decades. In a worst-case scenario where bad events lead to worse decisions, opines Stephens, the domino chain could even lead to a British exit from the EU.

"Worst-case"? Au contraire, the sooner the better, and for the reasons he has given in his exploration of Europe's problems.

Is now a good time to invest?

I've just been asked by a client whether he should switch from cash to equities. Here's my view, and it may explain why I haven't earned much from investments over the last few years:

It is not possible to predict the market with any accuracy, but I think I have done well in foretelling the current state of affairs as early as the late 1990s. The market has dropped to half its 1999 peak (again, as it did in 2003), but that is not to say we are now at the bottom. Some (and I am moderately persuaded to this view) think that there may be a "bear market rally" soon-ish - maybe a rise that recovers perhaps 50% of the losses so far - but it is perfectly possible that the underlying trend is still downwards, so there may then be a horrid lurch towards - what? Maybe, ultimately, 4,000 on the Dow and 2,000 on the FTSE.

We are in the middle of an exciting ride and I fear that entering the market at this stage may still be for the adventurous and nimble. Yes, had one invested in mid-2003 and got out, say, late 2007, it would have turned a nice profit; but much depends on the entry and exit points. So as ever, attitude to risk and corresponding watchfulness are key factors.

There is also the question of what asset class to choose. I think domestic and commercial property are still overvalued, relative to income; because of fears regarding other assets, and also because of central bank investment ("quantitative easing" etc) government bonds are very highly priced, which is why the yields are so low (and if interest rates rise, bond values could then drop sharply); equities are depressed, but as dividends decline in very testing economic conditions, they may ultimately be depressed still further. Commodities (e.g. gold, silver, oil) are the subject of some speculation, but owing to shortage of borrowed money to invest with, not quite so much institutional speculation as formerly; even so, gold (for instance) is a bit above its long-term inflation-adjusted average, as far as I can tell - though if inflation takes off, the price could indeed escalate.

And then there is the question of currencies. The pound has lost heavily against the dollar; but some say the dollar may catch us up again. The Euro may also not stay as strong as it is now - several countries within the Eurozone are suffering economic problems and are hampered by the common currency; I have even read speculation that the Euro system may fall apart within a decade, or some states may secede from it.

In short, I still urge caution, and if you do decide to get in, be prepared to move quickly if the market should turn. Meantime, there are relatively safe options such as National Savings Certificates, including the index-linked ones that will at least keep the value of your savings roughly in line with RPI...

Wake Up!

Jim Mellon and Al Chalabi, authors of "Wake up!" , have emailed their latest interesting and useful newsletter. It concludes:

Our strongest recommendations are as follows:

• Prepare for rising inflation – continue to buy gold;
• Sell government bonds;
• Look for cheaply valued strong stocks – BAE and BP in the UK are two examples, and in the US we like Pfizer.
• Deploy cash wisely – our current favourites are, believe it or not, the British pound; the yen is weakening, but at 100 yen to the dollar it is a buy again.
• Avoid the US dollar and the Euro.

Like that bit about the pound - I was scratching around looking for something to save what's left of the savings.

Symmetry; asymmetry

"China’s January surplus ($39.1b) is roughly the same size as the United States’ December deficit ($39.9b). It is reasonable to think it will roughly match the United States January deficit as well.

The extreme symmetry captures something real. Deficits and surpluses are shrinking globally now that the price of oil is at levels that roughly cover the oil exporters imports. Right now China’s (growing) surplus is clearly the main counterpart to the United States’ (shrinking) deficit" - Brad Setser

"I believe there is a greater than 25pc chance of a departure from the Eurozone given the social and economic behaviours of some countries within it" - John Moulton on the UK and the Euro.

Denninger: deflation

Belatedly, I refer you to Karl Denninger's end-year review and forecast. He sees continuing deflation, and makes a number of other plausible and worrisome predictions - scroll to the end of his post for the horrid gallery of prognostications.

In short:

...rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance, get stingy and prudent. Your personal financial survival could well depend on it.

So instead of staring at the low interest on your cash balance, think of the real capital appreciation of your money as measured by what big-ticket items it will buy. And for once, the government can't easily tax your capital gain.

You may also want to hold more cash away from a bank ("Round #2 of severe bank instability gets served up on us in the second half of 2009").

And maybe diversify your currency holdings:

The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are... The rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example... I see the potential for the pound and euro to both reach par with the dollar.

I think Denninger on the one hand, and Faber/Janszen on the other, may both be correct. It's a matter of timing - deflation now, debasement of the currency later. Because nominal debt gets relatively bigger as assets and incomes decline in value, something will have to give.

Global monetary inflation and the threat to peace

Last week, I suggested that we could be entering an era of competitive currency devaluation. Now, Mish sees it happening in Russia, Mexico, Indonesia - and hints of intervention in Japan. The Canadian National Post predicts a drop in the US dollar, too (htp: Jesse).

Can the Euro -already strained by member countries moving in different directions - take this pressure? A friend told me recently of an old restaurant incident involving people he knew, where first one "did a runner", then another, so that the last man left at the table was stuck with the whole bill. This is a game that punishes the virtuous.

Gold is supposed to be a haven in such conditions, but is already above its long-term post-1971 trend, as I show here. So the bold investor might buy in now, knowing it's high but hoping it'll go higher (or fearing that other things will go lower still). Others say silver, or oil, or agricultural land. "The best lack all conviction, while the worst / Are full of passionate intensity."

These are tricky times. As in revolutions generally, it's hard to see which faction will be victorious, but loss, injustice and confusion are certain: "we are here as on a darkling plain / Swept with confused alarms of struggle and flight / Where ignorant armies clash by night."

This may seem over-dramatic; but when money ceases to be dependable and deadly dull, everything else becomes much too exciting. If the middle classes suddenly find their savings wiped out by inflation, their assets generally devalued and their businesses and employment under threat, watch out.

You've had your warning

Lord Myners has been criticised for telling the truth too early, i.e. 3 months after the general public could have done anything to save themselves. On October 10, "major depositors" in the USA and Japan were preparing to withdraw their money, and were willing to paying any attached penalty to do so.

For the rest of us, the corralito: "The Mail on Sunday has been told that the Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals."

Even if they had caught wind of it, would we have learned anything of this from the mainstream media? (Scornful laughs) But what were MPs doing with their own money? Perhaps they'd have abandoned us to our fate, like Lord Jim. (I have often thought that the main reason for getting into politics is the opportunity to trade - in all sorts of ways - on inside information and networking).

Do you think the banks have been saved? Mish doesn't think so. Is the pound safe? Jim Rogers doesn't think so (though this business associate of the sterling-busting George Soros may be playing a nasty little game of market manipulation - which is, scarcely credibly, not an incarcerable crime but merely a civil offence.)

Within the past 12 months, the pound has gone from USD $2.12 to $1.43 and Euros 1.40 to 1.06; to put it another way, imports now cost 48% more from the States , and 32% more from Europe. (O&A typical cash rates)

At least you can still get your hands on your money; but for how much longer? It may be that the crisis is over; but it may be that we are in the eye of the storm. Personally, after settling debts I intend (a) to draw extra cash, keep the slip to prove it's been legally obtained, and store it safely away from a bank; (b) to keep at least some of my money in foreign currencies - perhaps the Yen* and Euro*; (c) to look for a variety of non-cash stores of value - and not all of them with Government guarantees, either.

My trust in banks, politicians and journalists is broken. My faith in them is gone, because they did not keep faith with me.

*Though The Big Picture thinks Japan will move to weaken the yen and the Euro-zone is struggling to hold its members together. So, US dollars?

Running repairs

VoxEU describes the international economic strains in the Euro area and the need to patch up the collective fuselage so it can continue flying. I'm not an expert, but it looks like a mess to me.

Pic: "A rocket fired by an enemy fighter inflicted this damage on The Sack, a B-17 of the 379th Group. A 14-inch fragment of the rocket tore the pants off of the turret gunner without hurting him."

Smugness, alla Italia

Jonathan Russell writes in the Telegraph:

Spain's finances are in the dock thanks to Standard & Poor's, the spreads on Greek bonds have soared and Germany's economy is set to deteriorate faster than ours, according to the OECD. Suddenly the euro doesn't seem like such a one-way bet.

But where is the usual suspect, Italy, in all this euro-doom? Sitting pretty according to its finance minister Giulio Tremonti. The country didn't get involved in the sub-prime crisis and GDP figures could be significantly better than reported.

How do you work this out? "Our banks suffered little from the sub-prime crisis. There are few of them where English is spoken," he told Les Echos newspaper, no doubt not in English.
And GDP? "One should be suspicious of GDP figures …they do not include the informal economy."

The Italian "informal economy"? I'm sure there is another word for that.

And as one of my earlier posts shows, they've also invested less than 1% of their officially-declared GDP in US Treasuries.

Where to turn?

People are starting to run around looking for a haven for wealth. German bond issues partially unsold; US bonds yielding virtually nothing yet at risk of default and dollar devaluation; the UK's economic fundamentals worse than America's (without the advantage of having the world's reserve currency); others saying the PIGS (Portugal, Greece, Italy, Spain) may crash out of the Euro, and that the Euro itself may not see out another ten years.

Marc Faber is predicting that precious metals will outperform equities and bonds; this commentator reckons silver will outperform gold.

Dear me.

Relativism

It's hard to measure what's going on, because currencies have turned out to be rulers made out of very stretchy elastic - especially for us Brits, recently.

In this article, Kurt Kasun reproduces a chart from Marc Faber's latest newsletter, showing an estimated drop of c. 50% on the world's stockmarkets - a loss of some $30 trillion.

So I've looked at the Dow and the FTSE, as priced in Euros, since the Euro appears to be more stable than either the dollar or the pound sterling (until we discover the supermassive black hole at the centre of the European financial galaxy, no doubt).

Europe is keeping China (and America) going

A very interesting piece by Brad Setser, where he shows that the EU's currency strength and growing imports from China have offset the levelling in demand from America. His bottom line is that China's making money from us and lending it to the US.

Deflation hasn't happened yet; interest rates to rise, eventually

Jesse argues that we're not yet in a deflation, technically speaking; it's "the transfer of wealth from one asset class to another". So the money is merely changing pockets.

But after that, he expects (as I suggested yesterday) gold to rise sharply: "the move in gold will obtain explosive momentum from which a major rally leg will occur as the banks lose control." The euro, too, he thinks; and oil will stay high. So he concludes that when the pent-up liquidity starts to flow in the system, the US will have to raise interest rates to prevent a relative decline in the dollar.

Marc Faber: backs US dollar against Euro, US economy better than Europe's

Here.

The New World Order

I said earlier this week that rich and powerful foreign investors will call the tune now, and London Banker relays a threat from the Chinese re Fannie and Freddie. Unlike the domestic citizen and taxpayer, these people absolutely will not be stiffed.

Which is why we will get high interest rates, to prevent robbery-by-inflation. Which is why cash may remain on its throne for quite a while yet.

The question remains, which currency? One says the yen, another coughs and says "Euro." Wish I knew.

The view from Agamotto's Eye

Doctor Strange and the all-seeing Eye of Agamotto

Mish relays an interview with Marc Faber, who is a bull on the US dollar (not US stocks) and Japan.

"Europe will have to cut interest rates as well, and their economies are most likely much weaker than perceived...

... We are in a seven year bull market for commodities, so commodities can easily drop 50%. Some have already done that like nickel, lead, and zinc. Others will follow. But after that, I think that the bull market in commodities will reassert itself. But my view was that for the second half of 2008 commodities would go down."

What goes around, comes around

Rob Kirby quotes the Privateer newsletter's report that the European Central Bank is furious with Britain, for borrowing vast sums of Euros and forcing the stock of Euros to inflate.

Interestingly for me, he relates this action in part to the UK's having taken on so much of US Treasury debt, a matter on which I commented repeatedly some time ago.

Much to discuss

(Daily Mail story)

"Business was off the agenda" said the Telegraph yesterday, about the Saudis' visit to Britain. I'm not so sure: somewhere in that 22-car convoy there may be a Saudi who had quiet talks with his opposite number about economic matters, while King Abdullah distracted the cameras.

Alex Wallenwein in SafeHaven yesterday reminds us that a month ago, the Saudis refused to cut rates to match the US. He sees the dollar's resistance to collapse as having bought time for European and Eastern economies, and the Euro currency, to strengthen their position. Soon, it may be takeover time, and contrarians who expect the dollar to bounce back may find that the trampoline has been whisked away.

Dollars, gold and words

A couple of useful items from Financial Sense:

Gary Dorsch (October 18) explains that a falling dollar helps the S&P 500, "which earn roughly 44% of their revenue from overseas, mostly in Euros", and supports house prices in the US; but it also raises the price of oil, gold and agricultural commodities. While the US seems set to cut rates further, the Eurozone may raise theirs to control inflation. In five years, the Brazilian real has doubled against the dollar! Oh, to have been a currency trader.

Meanwhile, Doug Galland at Casey Research explains that gold was dipping together with shares, because institutional investors were scrambling for cash in the unfolding credit crisis. His view is that in the longer term, these sectors will diverge and gold will soar. He supplies an eloquently simple graph:

Speaking of eloquence, financial writers know their business but many need to hone their writing, so I propose a new prize: Sackerson's Prose Trophy. The first winner is Doug Galland, with the following simile:

Though admittedly impatient to see the gold show get on the road, we were largely unconcerned by gold’s behavior. That’s because our eyes remained firmly fixed on the perfect trap set over the years for Bernanke’s Fed.

Like hunters of antiquity watching large prey grazing toward a large covered pit, the bottom of which is decorated with sharpened sticks, we watched the handsomely attired and well-groomed Bernanke and friends shuffle ever closer to the edge, their attention no doubt occupied by pondering the flavor of champagne to be served with the evening’s second course.

One minute pondering bubbly, the very next standing, wide-eyed and hyperventilating, on thin cover with decades of fiscal abuse cracking precariously under their collective Italian leather loafers. We can’t entirely blame Bernanke for the dilemma he now finds himself in; it was more about showing up to work at the wrong place at the wrong time.

The second paragraph is splendid in its anticipation, and the phrasing conveys both the anguished expectation of the hunters and the relaxed, expansive mood of the prey. The denouement is a little disappointing: "pondering" is a repetition and the syntax is too florid; a short sentence would be better, contrasting the suddenness of the fall with the slowness of the approach.

Further nominations for Sackerson's Prose Trophy are welcomed.