Dollar & Gold & Four Sheets

An old expression is often used. Most people remain unaware of its origin. "Joe is three sheets to the wind!" means Joe is stinking drunk, smashed, plastered, intoxicated, inebriated, and who know? he might soon go meet Ralph out back (i.e. vomit). Several years ago, a learned man of letters explained to me the meaning of the phrase, which came from the world of sailing. If a sailor loses control of his sailboat, which could be from heavy imbibing of alcohol (or fishing or reading or man's favorite dance sport), the three main sails are let loose to the wind, flailing thrashing and whirling around, not pulling the boat. The three sails (called sheets) are exposed to the whim of the wind. Well, the USDollar and gold have four sheets which are now heavily torn by the wind. Before identifying the sheets, a preliminary glance at some critical events to bear heavily on world finance. These topics are more fully developed in the upcoming June Hat Trick Letter due out in mid-month.

US Treasury Secy Hank Paulson expertly states the Wall Street case, or is it disinformation? If these words do not put a chill down your spine, in an Orwellian tone, then you are missing something big. The vital topic cited is TRUST. We have come to see almost every single major economic statistic as falsified, most financial markets interfered, cozy insider agendas exploited, and regulatory bodies sitting on their hands. Paulson actually has spoken about the key test of accurate financial reporting as being trust, and defends it without blinking.

Accurate and transparent financial reporting is vital to the integrity of our capital markets and the strength of the US economy. In an address last November, I spoke about the importance of strong capital markets, pointing out that capital markets rely on trust. That trust is based on financial information presumed to be accurate and to reflect economic reality. Our capital markets are the best in the world and so is our financial reporting system. We must work to keep them that way. Today, the Treasury department is announcing several important steps to ensure we preserve an efficient financial reporting system that provides reliable information, is supported by a sustainable auditing industry, and has enhanced compatibility with foreign reporting standards.
-- Henry Paulson, 17 May 2007

The entire Strategic Economic Dialogue (SED) between China and the United States is incredibly flawed from the start. They could buy some time. To highlight the misplaced blame, take note that 60% of all Chinese bilateral trade surplus with the United States is derived from sales to US customers from US-owned firms operating in China. Hypocrisy is ripe, and insider agendas are clearly at work. My personal suggestion is that work be done, new paths forged, toward a Asian-Western pact on contract law and rigorous enforcement. The US continues to miss out on $60 billion per year in IP royalties with China. Russian energy projects also have contract law frustrations. The yuan is NOT the device to resolve the trade gap. Paulson knows better. US Congressional leaders continue to call the yuan currency regime an export subsidy. In reality the labor cost advantage is the actual export enabler, subsidized by enormous population replenished each year. Chinese Govt officials suspect that rapid reform as suggested by the USGovt would result in a series of sudden shocks such as what happened with Thailand and East Asia in 1997, known as the Asian Meltdown. The USGovt might be attempting to cause shock waves and dislocations in China, in order to weaken China. The immediate backfire of a quantum jump in the yuan valuation might be a sudden decline in USTreasury Bond purchases by China, which by the way is probably the only buyer in Asia these past few months. It is doubtful any American leaders or people comprehend the impact of a swift yuan rise on Chinese agriculture.

SHEET #1: EURO CENTRAL BANK HIKES RATE
The Euro Central Bank hiked interest rates by 25 basis points, as expected, to 4.0% this week. If the central banks were to collude in order to provide the USDollar a grand assist with a delayed hike, this was an opportunity. The ECB gave no help to the teetering buck. The futures market in Europe reflect another one or two rate hikes by year end. They show an anticipated official rate of 4.51% in December. The pressure is acute for further euro currency appreciation, and further US$ decline. The DX dollar index is likely to test the 80 level this year. The euro-based carry trade continues. Borrow cheaper euros and take advantage of the 1.25% differential versus the official Fed Funds rate. The long end has a 1% differential as well.

Some wonder why the USTNote 10-year yield has risen above 5% recently when economic growth has slowed, when consumer prices are tame, when housing slumps. It might be best explained as keeping a constant differential with the 10-year German Bund yield. Check the carry trade inner workings. As usual, the US investment community ignores the rest of the world, out of ignorance, out of isolation disinterest, or out of desire to misrepresent. My forecast of a 4.0% USTNote yield seems incorrect. The miserable 0.6% GDP for 1Q2007 has been ignored. Price inflation has worked into far too many pipelines. Carry trades from bond speculation must be kept in order, since bonds rule, not economic fundamentals. One should never lose sight of the fact that a combination of rising US long-term bond yields and a slipping USDollar is the worst possible scenario for foreign central banks holding a mountain of FOREX reserves mostly in US$ denomination. On the domestic front, rising long-term rates result in rising fixed mortgage rates, exactly what the housing market does not need.

SHEET #2: MEMBER ECB BANKS DUMP GOLD
The Euro Central Bank has seen combined gargantuan sales of gold bullion. Without those sales, the ailing weakening wobbly USDollar story would have surely lifted gold over the $700 mark. The dump of 170 metric tonnes of gold bullion over the past three months tends to slow the bull, a heavy load for any four-legged animal to tote down the road. That figure includes umbrella ECB organizations. The April and May gold price was frustrated at that critical $700 mark, turned down, but has found its mojo again. Perhaps the big negative has turned into a big positive, as the ECB public statement claims 'no interest' in future gold sales. While they do not obfuscate as much as their American counterparts, one is hard pressed to take any ECB public statement at its word. Nevertheless, the gold price jumped back toward the 670 handle.

The quiet riot occurs in Spain. Last month in the Special Report on foreign lands update, Spain was featured as hosting a crippling housing decline, a mortgage crisis, a cascade of adjustable mortgage resets, a banking liquidity problem, massive federal deficits, and a central bank meltdown. The Banco de España, has in this calendar year liquidated (dumped) a total of 80 tonnes of gold bullion. They are in a panic, selling off all available assets of any and all liquid variety. No federal European Union government organization exists to come to Spain's aid. The ECB has no system to grant a bailout relief loan. An acute housing millstone drags down the Spanish economy, and Spain is the grandest abusive agent on official desperate gold sales. Let's be clear. NOT ONE PEEP ON MAJOR FINANCIAL NEWS NETWORKS HAS BEEN GIVEN TO HUGE CENTRAL BANK GOLD SALES. A vested interest is engrained not to properly inform the public about gold or how its price fluctuates.

SHEET #3: SOVEREIGN WEALTH FUNDS
Recent events emphasize the power and impact of what are lately called 'sovereign wealth funds' by the finance sector, since managed by government ancillaries on FOREX reserve accounts. The principle wellspring of these funds is Asian trade surpluses and Persian Gulf petro surpluses. China has set aside $300 billion. The Chinese trade surplus grows at $1 billion per day, most of which will be diverted to their investment fund, as announced. The two largest such state-run funds are managed by the UAE at $875 billion and Singapore at $330B. The Saudis, Norway, and China each lord over a $300B fund. Several other nations command a sizeable fund. These funds have several alternatives, with private equity funds (see suspicious Blackstone deal) being clearly the worst choice from an open market perspective. Pursuit and broad bids on energy, mineral, and commodity properties is what we should prefer to see in order to provide a continued wind to the commodity bull market.

State account managers feel a fiduciary responsibility to pursue greater returns with less US$ currency risk. This surely means lower yielding and less liquid assets, as a trade-off to sidestepping grandiose US$ risk. My contention has been for the last several months that China would lead a global movement to invest in commodities, via crude oil stockpiles, futures contracts in forward years, raw ore stockpiles, foreign properties, and foreign companies owning leases. The movement is catching on exactly as forecasted. Numerous complications are involved, however. Obscure motives, political objectives, strategic initiatives to secure resources, and secret agendas can be put to work. Insider corruption, cozy crony deals, and secret quid pro quo agreements are possible to occur.

(and lastly, the most important)

SHEET #4: PETRO-DOLLAR TORPEDOED IN PERSIAN GULF
The first pillar of USDollar support was removed last year when Asia (ex-China) essentially halted USTBond purchases with trade surpluses. The second pillar of USDollar support is in the process of being removed, as the Persian Gulf nations are splintering that pillar. The Gulf Coop Council (GCC) has an initiative which seems dead long before arrival, that to form a single currency for oil exporters in the Gulf. In May, two nations broke from support of the USDollar, Syria and Kuwait, both ending their peg to the US$. The GCC is comprised of Saudi Arabia, Qatar, the United Arab Emirates, Bahrain, Kuwait, and Oman. Their plan for a unified currency is in deep trouble, if not doomed, unless departure from a tight USDollar link is part of the process. Individual nations are responding in their best interests. WE ARE WITNESSING THE BEGINNING OF THE END OF THE PETRO-DOLLAR DEFACTO STANDARD.

The Bretton Woods II economic myth has been shattered, reliant heavily upon Asian trade surpluses and Persian Gulf petro surpluses. The USDollar and its alter ego USTBond will take the heat and feel the pressure from lack of pillar support on the financial sector front. The so-called nonsensical Asset Based Economy promoted by charlatan Greenspan has turned sour, its alchemy exposed, as expected here. The USDollar and its alter ego USTBond will endure mixed pressures from a profound weakening of the USEconomy, like a slow descent into quicksand on the tangible economic front.

Most Persian Gulf nations are heavy importers to their economy. Thus they have an embedded deep risk when they link their currency to the USDollar, of rising prices for all things imported. The Kuwait price inflation runs over 5% for 1Q2007. The UAE posted over 10% CPI. Steady staid Saudi Arabia suddenly is running at 3% in CPI. Their collective loyal linkage to the US$-based system has ensured substantial price inflation both from import price rises and heavy bank lending of surplus funds among banks. Broad money supply growth in the GCC region is ramping at a 20% rate, twice that of the United States. In effect, the United States has exported massive monetary inflation to a principal supporter, the OPEC Arab nations. Their responsible reaction to fast rising price inflation might fracture the Petro-Dollar standard itself. A solution of sorts requires GCC member currencies to engineer a rise in their US$ exchange rates. The Gulf Coop Council has forced the issue!

Syria chose to tie its currency in a clever fashion according to the Intl Monetary Fund special drawing rights. These are certificates governed by a defined basket of currencies including the USDollar, the euro, Japanese yen, and British pound sterling. The signals are pointing to more defections but at the same time the makeup of the GCC currency to be a basket. The Chinese moved to a basket makeup for their currency. Watch the OPEC Arab nations do the same and potentially embrace a basket as an alternative to rigid US$ linkage. Forward currency markets in the MidEast offer some adequate clear signals on which nation will break next. The UAE is probably next to defect with its dirham, rather than Qatar with riyal.

USDOLLAR FEEBLE BOUNCE
The USDollar is at a critical crucial important point. The feeble bounce did not even reach the 20-week moving average on this brief cycle. Much depends on whether the Euro Central Bank continues to raise interest rates again this summer. Europe contains curve balls. If Spain melts down, a flight into the USDollar could ensue, at least temporarily. Without much doubt in the near-term, a challenge of the multi-decade critical support in the 80-81 baseline is coming. If the Petro-Dollar conventional is broken, if the Arab oil producers distance themselves from the USDollar, if Persian Gulf nations take steps to protect themselves from inflation (imported from the Untied States), if the Europeans indeed hold off on additional gold bullion sales, the USDollar will repeatedly scrape against the 80-81 critical support level. Until support breaks. THAT DOES NOT ADDRESS THE US HOUSING CRISIS AND MORTGAGE DEBACLE, neither of which has ended despite indefensible hope-filled claims to the contrary.

Two key items deserve mention on the currency front as seen through the crude oil lens. The Brent crude oil price penetrated the $70 mark. A rising crude oil price pushes the USDollar down. Without the illicit JPMorgan suppression of future crude oil prices out of its Bank of Baghdad renegade office, West Texas & Saudi crude oil would be selling for a similar price. The Commodity Futures Trading Commission seems asleep on the job. Also, the Canadian Dollar has been buffeted by the strong crude oil price. More than that, the loonie is lifted by a new 'hands off' policy by Dodge at the Bank of Canada. The loonie is up 10% since March, almost 5% in the past month. A rate hike in Canada would actually lift the loonie even further, thus talk of no overheating in their economy. A rate cut by Canada would unwisely offer their housing bubble new life, always a reckless decision. The neighbors north of BubbleLand are just as stuck without monetary policy alternatives as the US Federal Reserve. The Canadian Dollar will reach parity, exactly according to my longstanding forecast here since 2003. All Canadian stock investments receive a hidden dividend, worth 50% since 2002. Look for export subsidies to Ontario manufacturers in the future, financed by energy and mineral and resource sales, for an interesting compromise designed to save jobs.

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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]