Bailout failure accelerates dollars decline...
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In This Issue..

* Senate rejects auto bailout...

* ECB pushes back from the rate cut table...

* Goldman and Citigroup predict a dollar fall...

* China to continue to appreciate...

And Now... Today's Pfennig!

Bailout failure accelerates dollars decline...

Good day... Not sure when all of you will be receiving this today, as it took nearly over a half hour for my computer to boot up this morning. But its all good news for currency investors, so I'll get it written and out to you as quickly as I can. The dollar slowed its decent overnight, but continued to fall vs. most of the major currencies as the US Senate rejected the $14 billion bailout for the auto industry.

The big winner in the Senate rejection of the bailout plan was the Japanese yen, as Japanese car makers are predicted to grab an even bigger piece of the US auto market. The yen, which has been rallying due to global deleveraging and carry trade reversals, suddenly had another reason to rally. The yen rose to a 13 year high, trading below 90 yen per dollar, and some are now predicting a rise to 80. Finance Minister Shoichi Nakagawa boosted the yen further after telling reporters in Tokyo that Japan isn't considering intervening in the currency markets.

But even before the automakers got the bad news from the Senate, the dollar was falling faster than we've seen in the past few weeks. Chuck shouted out across the trade desk around noon yesterday that the dollar index, which tracks the greenback against the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc, had fallen below the 55 day moving average. This is a major level for technical traders, and signaled the dollar could be headed for a further fall.

The data released yesterday showed initial jobless claims in the US surged to a 26 year high as the recession deepened. Claims increased to 573,000 last week, an increase of 58,000 from a revised 515,000 the previous week. The total number of workers staying on the benefit rolls jumped to just below 4.5 million, the most since November 1982.

While the markets had predicted another increase in the jobless claims, the trade deficit numbers were a big surprise. US exports slid to a seven month low causing the trade deficit to widen to $57.2 billion in October. No one I read was predicting a widening deficit. The worsening trade balance removes what has been the sole source of support for the economy during this recession.

A separate report issued by the Federal Reserve showed US household wealth fell by the most on record in the third quarter. Net worth for households and non-profit groups decreased by $2.81 trillion, the most since records began in 1952. So we have record unemployment, a widening trade deficit, and falling consumer net worth; not a good picture for the incoming President. But President Elect Obama has a plan, we can just spend our way out of this problem!! Chuck sent me the following comments yesterday afternoon:

"So... All this week I've talked about the President-elect's plan to spend more money since 1950 on infrastructure, which is fine in good times, but these are faaaaaaaaarrrrrrrr from "good times" for the economy... Well... Yesterday the P/E said this, "We understand that we've got to provide a blood infusion to the patient right now to make sure that the patient is stabilized. And that means that we can't worry about the deficit."

Can't worry about the deficit? Did I hear that correctly? Geez Louise, here we go again, sliding down the same old slippery slope of "deficits don't matter"! Aye, yi, yi! What is everyone smoking? I've said this before many times at presentations, and here in the Pfennig, but I can't pass this up... These people, who should know better, that claim that deficits don't matter, remind me of the guy standing on top of the Empire State Building, and decides to jump off... As he passes the 56th floor he says... "So far... So good!"

Well, that's right, so far he hasn't hit the ground! And... So far deficits have only bruised us, but they haven't hit the ground yet either! A quick look at my fave book on deficits, I.O.U.S.A. tells me that we've passed the $10 Trillion mark for Federal Debt... "today's deficits reduce national savings, which dramatically decreases productive investment and wealth-creating activities. Increased indebtedness to foreign lenders puts future financial decisions in the hands of people who may or may not have our interests in mind when they make them. Further, interest payments that have historically stayed home now provide more and more income to investors abroad."

"At the current rate, with existing laws, by 2040 the federal government will be spending twice as much as it takes in from taxes. Our children and grandchildren already face a more competitive, challenging, and uncertain world than most Americans have grown accustomed to."

Failure to recognize this by our leaders is the biggest mistake we can make... And comments like the one above from the new PE lead me to believe we'll have more of the same old "deficits don't matter" and that, my friends will eventually weigh heavily on the dollar...

Sorry to be so gloom and doom on a Friday... But that comment by the new PE just sent me reeling! Now, back to Chris..."

I've known Chuck for nearly 20 years now, and nothing gets his blood boiling as quick as the saying 'deficts don't matter'! The leaders of Europe sure think they matter, as the EU decided to trim down a proposed stimulus package, as Germany warded off calls by France and Britain for deficit-boosting programs. This announcement, combined with a statement by ECB council member and Bundesbank head Axel Weber caused the Euro to jump vs. the US$. ECB member Weber cautioned against reducing interest rates below 2 percent, suggesting the bank is probably near the end of its rate-cutting cycle. "If the benchmark rate sinks below 2 percent when medium to long term inflation expectations are just below 2 percent, that implies negative real interest rates," Weber said in an interview. "I would like to avoid that."

Weber knows the long term impacts of negative real interest rates, they are very inflationary. The generation before his lived through the German hyper inflation of the early 1920's which helps explain why financial leaders from Germany are such inflation hawks. So the 75 basis point cut by the ECB last week, which was the biggest in ECB history, will likely be the last cut for some time. The Euro has benefited from this perceived change in attitude. As of this morning, the Euro has risen over 5 percent vs. the US$ this week.

We have been suggesting that the recent dollar rally was not a change in the long term trend for the dollar, and some big name currency traders are starting to jump on our bandwagon. Goldman Sachs Group lowered its forecast for the dollar against the euro and the yen for 2009, saying the repatriation of overseas assets by US investors and demand for the greenback for funding are 'diminishing'. Goldman is now predicting the Euro will rally to $1.45 per euro by the end of next year, up from their previous prediction of $1.30. "We are at a turning point," Goldman's Jens Nordvig wrote in a research report. "We expect the dollar support from temporary deleveraging and funding flows to diminish, and, in that scenario, the underlying pressure from more standard sources should once again become more important." Sounds like he has been reading the Pfennig, as Chuck has been calling for a return to underlying fundamentals for a while now!

The folks at Citigroup are also jumping on the dollar bear bandwagon. "There are good indications that the US dollar is likely to weaken against many Asian currencies into year-end," wrote Tom Fitzpatrick and Shyam Devani, analysts at Citigroup. They went on to say the dollar will retreat from a two year high against an index of Asian currencies after breaching levels where orders to buy the greenback are clustered. They believe the dollar will fall vs. the Singapore dollar, Chinese Renminbi, and the Indian rupee.

The Chinese Renminbi continued to rally for a seventh day in a row, the longest winning streak since June. Assistant Finance Minister Zhu Guangyao vowed to keep the currency at a 'reasonable and balanced' level after the Chinese let it drop sharply on Dec. 1. China stalled the Renminbi's appreciation in July to aid exporters after letting it rise 6.6% in the first half of 2008. I think China will continue to slowly let the Renminbi appreciate, but will keep the pace of the appreciation at a manageable rate of 6 to 7 percent per year. China's economy is slowing, but Asia will continue to be the growth engine of the global economy. I still suggest investors allocate at least a portion of their investments into the Asian currencies of Singapore, Japan, or China.

Currencies today 12/12/08: A$ .6586, kiwi .5453, C$ .8038, euro 1.3363, sterling 1.4962, Swiss .8473, ISK 218, rand 10.2214 krone 6.8858, SEK 7.9616, forint 197.96, zloty 2.9621, koruna 19.488, yen 90.35, baht 35.01, sing 1.4918, HKD 7.75, INR 48.577, China 6.8433, pesos 13.3266, BRL 2.3684, dollar index 83.68, Oil $44.97, Silver $10.10, and Gold... $817.05

That's it for today... Drove the side streets in to work for the last time today. The highway department shut down a 5 mile stretch of interstate which runs from the front door of our office to my house. After a full year of taking side roads to and from work, I will be able to take the newly refurbished highway on Monday. This will drop my commute big time, and is great news for yours truly!! Chuck is off on his annual Christmas shopping trip with his buddies today. They start first thing in the morning and spend the entire day spreading Christmas cheer around town. Hopefully I will be able to meet up with them this evening, as they typically end their trip at a local restaurant/bar not too far from my home. Hope everyone has a Fantastic Friday, and a Wonderful Weekend!!!

Chris Gaffney, CFA

Vice President

EverBank World Markets



Posted 12-12-2008 9:32 AM by Chuck Butler
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