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Fleck Rap

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Note: Look for a weekly installment of Bill Fleckenstein's market rap to appear on Minyanville and further commentary once we launch Buzz & Banter.


Fed's Dollar Debasement Works 24/7 to Siphon Your Wallet

Overnight markets were basically a nonevent, and ditto our futures as we rolled into the preopening news that housing starts and permits printed a little less than expected. Around that time, the news was disseminated that ABC's consumer confidence poll (which tends to lead others, such as the one we saw last week from Michigan) had reported one of the biggest drops ever, from minus 6 to minus 13. A likely contributor to this: the results for a state-of-the-economy question, which dropped from minus 18 to minus 28.


Buxom Levels of Bullishness

About that time, someone who receives the Investors Intelligence data emailed me the latest finding, that bears were down to about 17% and bulls up just a shade over 59%. For those who don't follow the data, 60% has always been considered something of a magic number. This level is one of the things I mused about a year ago when discussing what could happen in the current rally. Well, it's taken a lot longer, and the market has gone much higher, but apparently we are damned near there.

Anyway, that medley of information didn't seem to matter much, as the casino opened to a little tug-of-war back and forth across unchanged, before settling slightly into the red a couple of hours into the day. The only thing of note was that housing stocks essentially ignored the aforementioned news.

Over the course of the day, the market action was pretty much a snooze, and as the box scores show, not much changed. Sure, there was the usual amount of speculation, with Rambus up 40% and NetEase up 25%, and other speculative fireworks as well. (Speaking of specific stocks, today's New York Times had a fine story today on the AMD/Intel battle, titled "Intel Concedes 64-Bit Chips Are Wave of the Future." I'll have more to say about that tomorrow, as the length of today's Rap precludes further mention today.) But as far as mainstream stocks go, not much happened today. The real action was in the foreign-exchange arena.


Forex Gets Exfoliated

Away from stocks, the major currencies were all over 1% lower. I did not detect much of a proximate cause, though there was some more ECB talking-head chatter, as well as French President Chirac's statement that more currency stability was needed for growth. But I think this was just noise which attached itself to the action. Of course, perhaps I could have jinxed the foreign currencies this morning when I decided to spill a bunch of ink on the problems caused by its decline.

In any case, though the precious metals were only down 1% during their session (since closing before the currencies), they did slide more when electronic trading began. Gold was down a further 0.5% and silver down a further 1%, in sympathy with the currencies' weakness. Oil was up about 50 cents to just a shade under $36, while copper was flat. None of that mattered to the bond market, which was also about flat.


Dollar Sports a Pariah Patina

I thought that for a change, I'd talk about the dollar (very big grin) -- not just concerning the "end game" (though an important development has recently emerged on that front) but also the ongoing game, to some degree. Last night, the Reserve Bank of India stated that it was "exploring the option of replacing a part of the central bank's investment in short-term U.S. securities with European gilts." For those who don't know, the Reserve Bank of India has a growing cash hoard of around $107 billion these days, making it roughly the six-largest holder of foreign currency reserves.

This follows on the heels of the comment by Japanese Finance Minister Sadakazu Tanigaki (noted here last week), that Japan would consider diversifying the composition of its reserves. So, at a minimum, there are a couple of important shots across the bow, showing our movement through the stages of the currency crisis I articulated last week. Though we don't know at what rate things will change, it does seem that momentum is building. One thing you can be sure of: When momentum gets going in the foreign-exchange arena, it tends to keep on going. Nothing quite "trends" like the currencies.

With the pressure continuing to build toward the end game, one might ask what that will look like, to which I would answer, it's anyone's guess (since today's distortions are so much larger than ever before). But it is worth noting that back in 1978, the Carter administration was forced to do a tremendous amount of heavy lifting to rescue the dollar. In addition to a handful of other measures, it was forced to borrow $10 billion worth of Treasurys denominated in currencies that it could not print. It's worth mentioning that our trade deficit was 0.7% of GDP at the time, rather than the 5% it is now. Said differently, today's is seven times bigger. (We had quite an inflation problem then, which was one of the main reasons for action on the part of the Carter administration.)


BLS Says, 'Take My Ex, She's Yours

Of course today, we don't see any inflation -- not because it isn't there, but because it's been so cleverly defined away, via hedonics and the makeup of the CPI, etc. (Speaking of fun and games with numbers, I note that the January PPI scheduled for release tomorrow is going to be delayed due to a new classification system by the Bureau of Labor Statistics.) And of course, Bubblevision and Wall Street like to delude themselves even further by looking at the CPI ex food and energy (or ex any other offending item), which when you step back a minute is one of the silliest notions of all time. If there's anything you have to spend money on every day, it's food and energy. Energy is so ubiquitous that even a box of Corn Flakes has a high energy component when you think about all the different things that go into the cost of production. The price of oil works its way into damn near everything.

That is one of the most obvious near-term and ongoing problems of our currency debasement scheme. In the last two years, the price of oil has risen from about $21 per barrel to just over $35 per barrel. OPEC's recent decision to cut production was partially due to the depreciation of the dollar. As Iran's oil minister, Bijan Nambdar Zanganeh, told Bloomberg at the time: "The dollar devaluation of the past year loses some of our purchasing power.


Killjoy in a Weaker Currency

Now, I am not saying that the price of oil would not have gone up in dollar terms anyway, had the dollar not slid. But perhaps it would not have gone up as much. As you will see, a strong currency thwarts price increases, while a weak one causes and exacerbates price increases. In the last two years, the euro has rallied from about 86 cents to $1.28. Over that space of time, Europeans have seen their price of oil go from about 24.5 euros per barrel to about 27.5 euros per barrel. That 12% increase is obviously a lot less than the 65%-plus increase which has occurred in dollar terms. So, the decline in the dollar has affected folks in subtle yet expensive ways that they don't quite recognize.

If we use the same methodology to look at a slightly different commodity, in this case copper, the 73% increase over that same time period seen in dollar terms would have been closer to 17% in euro terms. Naturally, copper doesn't enter folks' everyday life in the same way as energy, but the analysis is applicable to most other markets.


Paying Up for Palette

Another tasty example (if less ubiquitous) is the price of wine from Europe. I myself like good wine, and I can tell you that the drop in the dollar has affected and will affect even further the price that Americans pay for European wine. In some way, what's happened with wine has been seen in many areas, whereby middlemen have absorbed much of the pain thus far, but that's about to change, and prices are going to escalate. I could cite many more examples, but I think you get the point: When the dollar goes down, it costs you money basically every day, though in some cases, there are lags before the impact really starts to be felt.

Returning to a point I made earlier about how government statistics mask the inflation that eats away at your money, I would like to spend a minute on another problem that can result from massaged inflation statistics -- and that is central bank bubbles. One of the reasons why central banks can create a bubble is that they are so attuned to only recognizing one kind of inflation, i.e., CPI inflation. When there is an absence of CPI inflation (either because it doesn't exist or it's been defined away), central banks can keep the spigots open and precipitate a bubble.


Getting' in Greenie's Grill. . . .

That was the case in the 1920's here, that was the case in the late 1990's mania, that was the case in Japan in the 1980's, and that is the case currently as the wrong-way Fed is worried about deflation at a time when just the opposite is happening. In today's Wall Street Journal, Otmar Issing, a former Bundesbank member and now chief economist for the ECB, wrote an excellent op-ed piece that was a clear shot across Greenspan's bow, about this very subject of asset inflation.

Issing begins with the argument for why central banks have avoided asset prices in conducting monetary policy. Then he gives the reasons why this should be taken into consideration: "Huge swings in asset valuations can imply significant misallocations of resources in the economy. . . . " This is of course what happened during the 90's bubble. The response to the bubble was more printing and the collapsing of rates to zero, which have precipitated the problems that we shall face in housing, and have fomented this most recent stock market bubble.


Didactic on the Prophylactic

He goes on to state: "Prevention [my emphasis] is the best way to minimize costs for society from a longer-term perspective." I am going to say that again -- "prevention is the best way to minimize costs for society from a longer-term perspective" -- because it is absolutely the most important thing I have heard anyone associated with central banking say since Paul Volcker ran the Fed. This is the reason why one should not go down the path of bubble blowing, because it is impossible to painlessly unwind a bubble once blown. The only way to solve a bubble with not much pain is to not let it get started in the first place.

Issing does justice to the complicated nature of trying to gauge what is too much asset inflation. He likens it to plain-vanilla inflation by saying: "Asset-price inflation could similarly be characterized as 'too much money chasing too few assets,'" thereby laying the mania right at the doorstep of where it belongs -- the central bank. That is not to say the public is completely absolved of responsibility, especially if it falls for the same story line twice, as many have in this last go-round.


Spare the Discipline, Despoil the Dollar

But nevertheless, the primary responsibility belongs to the Fed. Its policymakers have created an environment in which the financial system has "broken," in which the massive imbalances it has created are helping to destroy our currency, and the summation of which will collectively make our lives and our children's lives more difficult prospectively. That is why I continually have such vile and bile when I discuss Easy Al and his clueless band at the Fed.

One last comment about Otmar Issing. Though in this day of wet-noodle central bankers he appears quite hawkish, he was anything but a hawk, compared to the old stalwarts at the Bundesbank. About the closest thing we have to real stand-up folks who appear willing to look ahead and solve problems before they get worse -- i.e., take away the punch bowl -- are the men from down under running the central banks in Oz and Kiwi land.



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