The Euro-Yen Crossfire

The real currency story in recent months is the euro-yen cross, and not so much the euro-dollar headline breakout. In Japanese yen terms, the euro is on a tear. Aiding the euro is significant Asian diversification away from the USDollar by their central banks. The Arabs also are diversifying, as much into the pound sterling as the euro. They are experiencing massive anxiety attacks as Iraq disintegrates. Hence, on a combined basis a giant long-term euro breakout has been in progress, having begun in early summer. This euro uptrend has actually lasted 18 months, and began at the key date of July 2005. That date has been cited numerous times in the Hat Trick Letter, when King Abdullah took the Saudi throne, and when the Chinese announced a major shift in the yuan currency program to permit its rise. Both events shook the financial world.

All changed after July 2005, heralding a new dawn. That time frame marked the beginning of the recent powerful stage in gold, which led to the May climax at 730, and the silver climax at 15. Give much credit to Barrick Gold, which covered a substantial block of their mind numbing underwater gold hedge book. On at least four occasions in the past year, my scribbles have cited this key July 2005 month, when in my opinion the earth as we knew it shifted on its axis. The USDollar has been on the defensive ever since Asia and the Arab world shifted emphasis to the EuroBond. No evidence suggests the uptrend is on the verge of interruption. The upper boundary of the euro ratio to the yen is under pressure, perhaps submitting to a mild correction. Both the 20-week moving average and the 50-week moving average are rising notably. When Asians and Arabs decide to change their strategy, that constitutes an earthquake, since the two are central pillars to capital supply, credit supply, and oil supply to the United States. Earthquakes will continue for years to come!

Since neither situation (Abdullah as king, Chinese yuan as unpegged) is likely to be reversed anytime soon, the positive euro bias is highly likely to continue. If the Japanese yen rises from Bank of Japan newly introduced rate hikes, then the euro cross will surely correct. The euro rise versus the yen gives the BOJ perfect cover to order its rate hikes, which will lift the yen. The loser is the USEconomy, which must adjust to higher import prices. Expect Wall Street goombas to find a positive spin. They always do.

GEOPOLITICS OF TRANSFORMATION
The global banking system has completed the early preliminary stage to transform into a shared world currency reserve structure. It is surely early. Given the extraordinary fundamental imbalances for the USEconomy (testimony in a current account deficit at 6.8% of GDP), given the significant dependence of the USEconomy (for energy, commodities, finished products, credit, and capital), given the mounting hostility of suppliers (namely Russia, Iran, at times China), sharing the world currency mantle with barbarian euro vagabonds will not go down without a fight. The interwoven nature of a dominant USDollar and a powerful military is never discusses openly, but valid in argument. A military ingredient to USDollar defense is as likely as a boxer resorting to punches to defend his home during a raid on his vegetable garden.

Two other boxers are in the ring, rarely even mentioned in a military setting. The older boxer lurks behind the Iranian curtain when not donning European colors, unrecognized by the US intrepid lapdog press. The bear is in key respects every bit the counter-puncher. It is Russia, which is assembling a gigantic energy juggernaut as awesome as Japan's manufacturing powerhouse in the 1980 and 1990 decades. The younger boxer hides not at all, strutting its national bird in the urban crane and boasting of unprecedented growth. The dragon possesses wisdom in battle from ancient times (see Sun Tzu). It is China, which has assembled its own archipelago of industrial plants. Being the nexus of the new alliances, Iran thus stands as the quintessential prize fight location. The Shanghai Coop Organization receives painfully little open public attention or discussion, despite its growing importance. SCO represents in my view all the energy components of OPEC with all the security components in NATO, but with zero US involvement and thus zero US dominance. Thus SCO must be smashed, at least demonized.

CRUCIAL JULY 2005 MONTH
Why is this month so crucial? For several momentum reasons which shook the foundation to the world credit supply and shifted the geopolitical axis. Two events led the phalanx of powerful ensuing tectonic shifts. King Fahd died in Saudi Arabia, and Beijing announced the release from a fixed Chinese yuan currency regime. Shock waves hit on two continents, then around the world. Since that month changes have occurred of extreme significance concerning:

• uncertain demand for USTreasury bond supply
• Saudi alliance strains with the United States
• diminished Arab support for the USDollar
• ongoing speculation as to the actual Chinese yuan currency basket
• Asian and Arab diversification away from US$-based reserves
• installation of euro-based petro sales in Iran & Russia
• mammoth strains between the USGovt Administration and most world leaders

More geopolitical shock waves will surface in future years from forces building behind the scenes. All things financial changed after July 2005, in a grand cosmic shift.

In July 2005, King Faisal died. The new King Adbullah took the Saudi throne, nowhere near the ally to the United States and England, as he has harbored much openly stated distrust for Western leaders. Abdullah has instituted significant changes to the management of Saudi petro surplus revenues, favoring the euro and pound sterling much more. Arab money managers generally utilize London bond brokers increasingly, so as to conceal their grand collusion with Western financial titans. Leaders in Riyadh and other sheikdoms want to avoid the embarrassment of coddling and cozying to Westerners in key financial matters while talking tough on the Islamic front to their vassals. To say relations between Abdullah and US-British leaders is strained is a gross understatement. After the Iraqi Civil War has escalated, and after the US Congressional power shift, those relations have become openly contentious. Reflection to the USTBond and USDollar are direct and immediate.

Arab bankers have revolted against US$-based securities. The United Arab Emirates announced a move to 10% of reverses to be held in gold bullion. Quietly, without any question, other Persian Gulf sheiks have worked with their reserves managers to migrate money toward the euro and pound sterling. They follow the Saudi direction, who lead in the region. They work to change their formulas in quiet.

In July 2005, Chinese leaders ordered the yuan to rise. They thereby ended a rigid yuan currency regime, one tied rigidly to the USDollar for over five years. The result has been two-fold. First is the substantial but so far relatively meaningless 5% upgrade in the yuan in 18 months time. Below is one of Gary Dorsch's excellent charts, retitled with thanks. One can assess the upgrade as meaningless since Chinese labor is 10 times cheaper than Western labor. Look for a 50% yuan upgrade in order to make a dent on the global arbitrage. Chinese-based costs represent only 15% of finished product prices borne in the United States, so prices will rise only slightly here. Second is the diversification of incremental Chinese trade surplus. Their central bankers and deputies have been barking up a storm for several months on not buying so many USTBonds anyway. IT IS CHINA'S NEW WEAPON, TO WIELD SELECTIVELY IN ORDER TO GAIN A SEAT AT THE G8 FINANCE MEETING TABLE, AND ANYTHING ELSE THEY WISH, FOR THAT MATTER. Leaders in Bejing absolutely bristle at being an invited member, sitting in the waiting room like plebeians. The collection of Asian central bankers has been rumbling for over a year about diversification, only to be met by US intimidation of some sort.

In summer 2005, Russia began to defy the USDollar hegemony. More precisely, it was after the GATA Yukon Roundup (organized by Bill Murphy) for the most foremost set of private dignities in decades. Comments were made by Russian Finance Minister Kudrin about the buck being unworthy for world currency reserve, mismanaged, horrendous fundamentals, all very true sadly. Russia also opened last year an oil exchange to sell crude in native rubles, but also in euros to Europeans as a favor. The effects will be made clear. Putin might find his exports suffer from a ruble rise, ordered from the ruble oil sale policy. A rising currency is a badge of honor but a hindrance to exports. The other message is accommodation to the Europeans, without question being courted from Americans. To the Americans, perhaps a less than subtle affront and insult.

On again, off again, Iran plans to sell oil in euros. This was one of Saddam's final errors of judgment, perhaps why Tehran leaders seem so gunshy. Copying the Russian model, Iran has intentions of selling oil in euro transactions, but seems to be reluctant to take the plunge. In my view, using the euro oil weapon might remove the potential power of having it at their avail to use. A wise old man once told how a weapons not used contains more power. We mere mortals are not privy to the dealings and threats behind the scenes which Tehran leaders must contend with. If Tehran hooks up a bank of computers to Swiss financial centers in order to process euros from petro sales, will viruses find their way into that bank to form a colony of havoc? Does Tehran possess the expertise to handle the entire setup outside the USDollar shadow? Better yet, would a rogue missile enter like an invited dinner guest? One of these months though, we will hear that Iran is running a brisk business selling oil and accumulating EuroBonds in full defiance of the shadows and pesky microbes.

Tensions run thick between foreign central bankers and the USFed. Well, outside Brussels and London. Common trailer trash ordinary citizens, namely those not employed by Goldman Sachs, are not kept in the loop as to the strains surfaced between world leaders and the aggressive incompetent stubborn unteachable boy scouts running the USGovt. The easier question to answer might be which governments the US Administration does have good relations with anymore. With Tony Blair one step out the door, even the loyalty of England is called into dispute. Oh yes, tiny but critical Georgia is a key loyal enthusiastic ally, whose leader resides in Tbilisi and not Atlanta. Not one American citizen in 10,000 could name the capital of the central Asian nation Georgia, but they can tell you about PlayStation versus XBox. Georgian leaders probably have an open barbeque invitation to the White House tenants and family. One can be certain that Vladmir Putin's ire has been raised. Does Tblisi suffer from drive by shootings, car accidents, small plane accidents, and errant poison ingestion?

EURO, GOLD & SILVER
The euro has some consolidation to do after the earthquake in late November. Whereas the stewards of fixed markets were on vacation for the euro breakout, the profitaking and correction had all the henchmen on the job in early December. Neither Europe nor Asia celebrates Thanksgiving, and Americans take this holiday seriously, especially the eating part. Never under-estimate the proclivity for any and all Americans, whether of normal build or mammoth girth, to put all mundane matters of state aside and celebrate by eating for three consecutive days. Sure, respites are required to digest, rest, and reload, but then it is back to the trough for more. Please pass the pumpkin pie. Meanwhile, the USDollar was exposed as vulnerable to foreign attack.

The trouble with currency shocks is a big rising currency leads to a troubled gold market with challenges to the gold bull in that continent or nation. Gold looks best in US$ terms nowadays. In euro terms, the gold price has turned down. While not exactly a breakdown, the gold-euro price is flat, with no threat of an upside move. Other important cycles appear to show signs of a prolonged struggle here. The silver-euro price is ABSOLUTELY NOT in trouble, none whatsoever. The same gold and silver price pattern is true in British pound sterling currency terms also, a turndown for gold, and no effect for silver. Gold fights the political battles while silver fights defaults.

The queer effect from the cross currency burst is that Japanese cars will realize an unfair price advantage in Europe. As reserves held in US$ denomination are shifted to euros, the yen on a relative basis has gained significant ground. Beware the beleaguered cries of foul against Toyota all across Europe, especially in Germany! The powerhouse exporter has the ear of the Euro Central Bank and the German bankers. Be it Audi, BMW, Mercedes, or Volkswagen, they will bark loud. If not them, then Airbus executives will make a phone call. Their brass does not cotton to losing a price advantage to Boeing, and having a less competitive design of their flagship product line. On the other end is a higher crude oil price for Japan to pay. They import over 99% of oil consumption, and its price has risen a quantum step. Perhaps the preliminary shock waves are to be felt in Thailand, just like 1997. Seek shelter from the storm.

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com. For personal questions about subscriptions, contact him at [email protected]