China Puts The Brakes On!

By Chuck Butler    Jan 20 2010 9:38AM www.caseyresearch.com

In This Issue….

* Risk Aversion sets in, on China's moves...
* Now, we know what's going on with the TIC's!
* Germany to step in to save Greece?
* Honkers losing value VS the dollar...

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And Now... Today's Pfennig!

China Puts The Brakes On!

Good day... And a Wonderful Wednesday to you! As I understand it, we are in for some Monsoon like rain today and the next couple of days... Living in a little river town, and having a creek at the back of my property, lends itself to cause me to worry when I hear things like Monsoon like rains expected... But... It's mother nature, I can't do a thing to stop it, so, I carry on... But worrying while I carry on!

The rain is falling on the currencies too... The dollar has rebounded very quickly the past few days, and there are no roadblocks right now. The risk takers in the markets are running for safety again, sent running by China's decision to curb lending and attempt to slow growth before their economy overheats...

You see, China was the linchpin for risk taking... For, with China growing, commodities were in need, and commodity countries were very happily sending those commodities to China... The Commodity Countries would then be flush with cash, rising job creation, and be confident about their future... Interest rates would rise to combat inflation in the Commodity Countries, and the Karma would be flowing for each respective currency...

But, China said... Whoa there partner! (say that like John Wayne would!) And... I don't blame them... They seemed to be the only major country that was experiencing economic growth, I mean China's most recent quarter will probably show GDP at 10%! Hey! It takes two to tango! And in China's case, it takes more than two to tango... So... They decided to throw some cold water on the heating economy, and see what they have when the smoke clears...

So... As we start today, the euro has fallen to below the 1.42 handle, after spending most of yesterday gaining back lost ground to the dollar. The Aussie dollar, which just 10 days or so ago, was heading toward 94-cents, has fallen below 92-cents, and so on... Shoot Rudy, even the darling of recent times, the Canadian dollar / loonie, has dropped back a bit... Risk taking is off the table...

The question is... For how long? In the past year, whenever risk aversion set in, it really didn't last too long, and all it did was provide cheaper levels for investors to buy! So... The question du jour is how long will the Risk Aversion last before investors get tired of the paltry yields available in places like the U.S., and Japan... The two countries that seem to be favorites of the Risk Aversion campers...

Yesterday I told you about the rising prices in things that I got from Larry Edelson's newsletter... today, I'll tell you about a few story headlines that I came across last night on the Bloomie...

1. U.S. Hog Prices `Rampage' Higher, Pork Demand `Caught Fire,'
2. Florida Freeze Kills Estimated 70% of Southwest Tomatoes, Other Vegetables
3. Sugar Rises in N.Y. on Speculation Supply Deficit to Widen;

So... the "deflationists that don't believe inflation is creeping all around us and ready to take our economy under, should pay attention here... Pork prices "rampage higher"... Florida freeze kills 70% of tomatoes, Sugar rises...

AS I've said before... this is just great... NOT! Soon we'll not only have a dollar that's robbing us of our purchasing power, but what dollars we have left will be getting eaten away by inflation... Where do I sign up for that?!

Also... I want to talk about something that I wrote yesterday regarding why the euro was seeing a slide down the slippery slope... I said it was the "German Investor Confidence falling again... but the more I thought about it, and then a reader asked me about it, I knew that the Massachusetts election was playing with fire in the currency markets too... The currency traders were looking the possibility of a Republican victory, which would not be a good thing for the health care bill, and therefore the dollar wouldn't have to worry about an additional $1.5 Trillion in deficit spending if the health care failed...

But as I told the boys and girls here on the desk... That still leaves $2 Trillion in deficits for this year that have to be financed... and I'll let you in on a little secret that's just the Robinson's affair... that last year's Treasury buying was propped up by U.S. financial firms that sold their toxic waste bonds to the Fed, and then took the funds and invested them in Treasuries... That plan that came together to work all that out? It is supposed to end in March of this year... So... without those financial firms buying The Debt, who will be there to pick up the tab? I'm very serious here folks... This is HUGE... Foreigners only bought about 1/3rd of our Treasuries last year...

Remember when I kept talking about the TIC's data, and wondering why the dollar wasn't getting punished? Because on the other side of the cocktail napkin, the Treasury was selling to financial firms, and the Fed, as I documented in the past... And all that comes to an end in March... Hmmm....

OK... I've been doing a lot of thinking about the Greece thing... and I know that I've ranted about how it shouldn't be on the minds of investors over the problems in California, New York, Illinois, Michigan, etc. but... it is... and so I think we need to deal with this, talk about it...

Now, you know my stance on the bailouts here in the U.S. and that hasn't changed, but it happened, and that's now water under the bridge.. the river may be swelling to take away that bridge, but it's water under the bridge today...

Well... It now looks like Germany is going to have to step in and bailout Greece... yes, I know that some European Central Bank (ECB) members have talked tough on Greece... I also don't believe that they would jeopardize the European Union and the euro by ignoring Greece... So... I now feel as though Germany will have to step in... If they don't... it could have a domino affect and cause some major harm to the euro... So, that's something to watch for...

The major harm might be short-lived... sort of like the slowest buffalo theory... where the slowest buffalo gets killed, but makes the herd faster... Greece would be the slowest buffalo here... OR... it could send things spinning out of control in the Eurozone... So... in this case, we will have to go with Germany stepping in...

So... Last week, I carried on about the Fed making $52 Billion last year, and wondered why this wasn't as big a deal as Exxon/ Mobil's huge bonanza a couple of years ago... I mean, at least when Exxon/ Mobil made Billions, there were stock holders that benefitted... Normal people, moms and pops, etc. When the Fed had the bonanza it handed it over to the Treasury, which some would think would go back to the taxpayers... Yeah, right...

But, I got to thinking this past weekend about the bonds the Fed is holding... No wonder they don't want to see interest rates rise! For, if interest rates rise, their holdings would take on water, and... The Fed has stated that they intend to sell these bonds back to the markets some day... Well, try doing that when interest rates have risen on your bond holdings!

And... What happens if interest rates rise so high that the Fed starts taking on water, with negative interest rates spreads on the their holdings? Talk about cries to audit them then!

OK... Let's go on to something else... This Fed / Treasury stuff gets me so riled up, and I start pounding on the keys! I've had to have my keyboard replaced about a dozen times in the past 10 years, but mostly in the past 5 years... Besides pounding on the keys when I'm typing something that ticks me off, there are times I just pick the keyboard up and slam it down on my desk! Now... Those of you who have ever met me at shows, etc. would think, not Chuck! He's so mild mannered, and easy going! It's my evil twin that does these things, folks...

Gold had a mini-rally of $5 during yesterday's trading, but overnight has sold off $9...

I want to make something perfectly clear, that I've talked about before regarding Gold... When I talk about Gold, I'm also talking about Silver... I just don't want to have to type Gold and Silver every time I'm talking about the precious metals... Silver is another store of wealth... In the December Currency Capitalist, I talked about giving the gift of Gold, and teaching whomever you gift it to, the lessons of wealth building... When my older kids were youngsters, I bought them Silver coins, for I could not afford anything else then... Those Silver coins have proved the point of providing a store of wealth, as they have never gone to zero, and have gained in value over the years!

OH! And the Bank of Canada left rates unchanged and kept their statement pretty much the same at their meeting yesterday. So... There was nothing there for the Canadian dollar / loonie...

And... It looks as though I was barking up the wrong tree yesterday with my call that New Zealand's inflation would be higher than expected, thus moving the Reserve Bank of New Zealand (RBNZ) to hike rates sooner than expected... New Zealand inflation actually fell in the 4th QTR .2% putting the annual inflation rate smack dab on the RBNZ's ceiling target of 2%... Now.. Having inflation at your ceiling target rate isn't anything to ignore... But this is going to push back my call for higher interest rates by 75 BPS by summer... It will probably only be 25 BPS and maybe 50 BPS by summer...

Across the Tasman in Australia... Australian Consumer Confidence rose in January by the most in 6 months! Here's another data piece that goes in the "pro" column for a rate hike in February by the Reserve Bank of Australia! (RBA) Job creation is strong as witnessed by last weeks jobs report, and now we have Consumer Confidence rising 5.6% last month! I would have to think that this pretty much nails it down for the RBA, and rates will me hiked at the Feb. meeting... Which, would put Australia rates a full 3.5% ahead of U.S. rates...

And then finally... I know I've gone on and on today... But finally... There was this... Our Foreign Bond Trader, Don Ries, came over to show me a bond issue that he found yesterday... Now... I must say that bonds are done in our brokerage, EverTrade Direct Brokerage, and are not FDIC insured deposits of EverBank... OK, now that I have that out of the way... OH! And this is NOT A SOLICITATION TO SELL THIS BOND! It's simply information to make you aware of things... The bond was a 7-month bond, issued by a supra-national bank, the IADB (Inter-American Development Bank) that's denominated in Brazilian real, that yields 7%!!!!

So... The reason I'm telling you this, is simply to show you one of the reasons the Brazilian real was posting a 35% return VS the dollar last year, and why the Brazilian Gov't was doing whatever it could to slow down the real's appreciation, which by the way, they have done! When you have bonds denominated in your currency yielding more than 300 BPS higher than the rest of the world, you're going to see a ton of interest in your currency to buy the bonds...

I'm still of the belief that the Brazilian Gov't's plans to stem the currency's rise will run out of steam... To me... It's just a question of when...

Oh! And one more thing this morning... I don't know if you track this or not, but the Hong Kong dollar has been slipping in value VS the dollar recently... I find this to be a strange thing, in that the honker is supposed to be pegged to the dollar...

A couple of years ago, I made a call about honkers saying that China would allow the honker to float first, since it was the more mature currency, and see how that worked out, before doing so with their renminbi... Could this be the beginning of that? Too soon to tell... But to see honkers losing value VS the dollar is strange... Strange indeed!

Well... The people of Massachusetts voted yesterday, and I think it says a lot when a state like Massachusetts doesn't elect a Democrat... Maybe, just maybe, the Gov't will get the message that deficit spending is not an approved thing by voters any longer!

To recap... The dollar is much stronger today, as Risk Aversion has settled back in the currencies, on the back of China attempting to cool down their economy. And then I carried on about all kinds of things!

Currencies today 1/20/10: American Style: A$ .9135, kiwi .7210, C$ .9635, euro 1.4165, sterling 1.6270, Swiss .96, European Style: rand 7.50, krone 5.7490, SEK 7.1550, forint 189.75, zloty 2.8375, koruna 18.2575, RUB 29.64, yen 90.80, sing 1.3980, HKD 7.7660, INR 45.92, China 6.8270, pesos 12.71, BRL 1.78, dollar index 78.06, Oil $77.90, 10-year 3.67%, Silver $18.54, and Gold... $1,129.50

That's it for today... Whew! My fingers are tired! Well... I sure had a lot to say today... It was good to see my brothers and sisters (minus one in Houston) last Saturday night. There were 7 of us... We lost my oldest sister to cancer, but remaining 6, have gone our separate ways, and seldom all get together... I just saw that an after-shock had hit Haiti... That country can't catch a break... There are heart warming stories though, like the German dog team that pointed out people caught beneath the rubble, and were rescued... Well... The Butler boys will be "batching it" for next 4 days, starting tomorrow morning, as my beautiful bride goes skiing with her "sorority sisters"... That means I'll be writing from home, and we all know how much I enjoy doing that! NOT! My little buddy, Alex, and I will be eating healthy in Kathy's absence... Yeah right! OK... Time to go... I thought I was early, but now it's late... UGH! I hope you have a Wonderful Wednesday...

Chuck Butler
Senior Market Strategist

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Two decades ago, Chuck Butler embarked on his extensive career in foreign investments as the Director of Operations for the Fixed Income Division of the Mark Twain Bank. He oversaw the clearing and custody of all bond department trades and Mark Twain portfolio transactions.