Questioning The Fed’s Rhetoric…

Good day… And a Happy Friday to one and all! It will be a Fantastico Friday (Hopefully) for the boys and girls in the St. Louis office, as we head to Busch Stadium tonight for a Cardinals baseball game… We even have a special guest that will be with us, so party on Wayne… Party on Garth!

Well… Things went a little crazy on the desk while I was away yesterday… When I returned home last night, I had a ton of emails from the Big Boss, Frank Trotter, and that’s usually a sign that things didn’t go well! Frank plays hockey on Friday mornings, and said he will call me to bring me up to date on his way to hockey…

The Big news in the currencies is that the dollar is on a roll… And is not taking any hostages! All this talk about higher interest rates in the U.S. has the dollar bulls giddy, and has really turned the negativism that had crept back into the dollar’s camp last week at this time, to be swept under the rug… You know me, I’m going to get on my soap box and rant about this dollar strength… So here goes…

The dollar rallied after hearing the news of the Retail Sales print… But as Chris told you yesterday, this was a one and done for Retail Sales… Yes, I know that some tax checks didn’t arrive until late in May, I would imagine those that arrived late, were offset by people in dire straits financially, that could not go out and buy that plasma TV!

Here’s Chris Gaffney’s take on the Retail Sales data… “I read a couple of articles which touted the American consumer’s resilience in the face of everything negative. I just can’t understand how consumers continue to borrow and spend. But how will the Fed keep the consumer happy going forward? I don’t think they have any more stimulus packages to pull out of their hat (although I read where Barak Obama is already calling for a second one). I still feel the next bubble to pop will be the consumer debt bubble which is reaching record levels. As consumers declare bankruptcy and walk away from their debt burdens, banks will again see massive write downs of their portfolios and the credit crisis will again be front and center on everyone’s minds.

But while currency traders are pricing in a FOMC rate increase sometime this year, economists are cutting their US growth forecasts for this year and next. They now project that quarterly growth will not exceed 2 percent through 2009. Soaring food and fuel prices, tougher lending rules and job losses will continue to hurt consumers. The weaker outlook means the Federal Reserve will forego raising interest rates until next year to combat inflation. Once this becomes more clear to the currency markets, the dollar will give back all of its recent strength.”

There was more bad news in the markets yesterday as Citgroup decided to close Old Lane Partners, a hedge fund co-founded by CEO Pandit that the firm bought for over $800 million less than a year ago. This is just another in the line of mistakes that banks have made with regard to hedge funds….

Well… In the “I told you so” compartment, I see that Lehman Bros cleaned house with their leaders yesterday. This was after posting some huge losses last quarter… You many recall me saying this would happen… But if you don’t… Let’s go to the tape of the June 3rd Pfennig when I said… “… It wouldn’t surprise me one iota if long after Lehman announces that loss that another “change” is announced…”

The markets are sweeping all this bad news under a rug folks… And you know me, I learned long ago that you can’t fight the markets… But you can call them DOLTS! I guess all this bad news isn’t “bad enough”…

The markets are all “jacked up” on the Fed’s rhetoric about “fighting inflation”… Which the markets take as interest rate hikes… But when? Next year? Oh, so you should give up the positive rate differential that the euro, Norway, Sweden, U.K., Australia, Brazil and others have VS the dollar because the Fed MIGHT raise rates in the next year? Shame on you all you pundits out there telling people these things about rate hikes in the U.S.!

Listen to me now, and hear me later… THE FED ISN’T GOING TO RAISE RATES! The ECB IS, but the Fed ISN’T! At least not for sometime, THE ISN’T GOING TO RAISE RATES! Did you hear me? Oh, just in case you were busy listening to someone on CNBC tell you that everything is beautiful, I said… THE FED ISN’T GOING TO RAISE RATES!

Over at CitFX, the researchers there put together a great commentary yesterday that our old colleague and Corporate FX guru, Ashish, sent along to me… The researchers at CitiFX thing this whole “interest rates are going higher in the U.S.” is a crock… The point out that the PCE (personal consumption expenditures) that is supposedly a fave indicator of inflation of the Fed’s was 2% last July before the sub prime meltdown… It now sits “drastically higher ?????” at 2.1%… So, where’s the emphasis to hike rates here?

They also point out that “we are looking at the only 3 severe economic downturns of the last 30 years and possibly the 4th now. The prior 3 were all jump started by a corrosive asset price fall (housing in 1979-1981 and 1989-1991 and equities in 2000-2002). In all 3 instances there were all preceded by an Oil price surge, which exacerbated the drag on the economy… And all 3 say massive easing cycles from the Fed lasting 18 months, 39 months, and 29 months respectively. (average 28 months)

They other thing they point out is that when unemployment rises, the PCE falls…

So… I’m not the only person screaming at the walls here, that the Fed’s rhetoric is empty, and can’t believe the markets have swallowed this hook, line and sinker!

One person not buying into this dollar strength (I’m told) is Pat Robertson. I didn’t hear this… But I was told that Pat Robertson of the 700 club said on his program that is followers should “get out of the dollar”, which is fine… But the important thing he said was to invest with EverBank!

One bank that did raise rates yesterday / last night was the South African Reserve Bank (SARB). This is the 6th rate hike in the past year… Other rate hikes helped push the rand higher VS the dollar, but I doubt this one will, given this mental brain drain going on in the markets right now…

So… We head into the weekend on a very sour note for currency holders… I said a few weeks ago, that we might have to deal with euro weakness, which leads to other currency weakness as the euro is the Big Dog, for some time to come… I even said that this could much like 2005, when the dollar rebounded, on the Fed’s rate hikes… But sooner or later, love is gonna get you, no wait! Sooner or later the traders all eventually come back to the underlying fundamentals…

An old friend gave us a subscription to the National Geographic. When an issue comes, Henry takes it and spends hours reading. This month, the magazine devoted the whole issue to China and Henry passed almost all of Sunday afternoon studying it.

“China is unbelievable,” was his judgment by evening.

Every detail is a superlative…bigger, faster, higher, more…more…more. Things are happening so fast that in just 10 years, China will be the world’s biggest economy. We don’t have to tell you what that means, dear reader. Give a guy some money and it’s not long before he thinks he can tell other people what to do and how to live. The United States became the world’s largest economy around 1900. By 1918, Woodrow Wilson was headed to France with his “14 Points.”

“God himself only needed 10,” said Clemenceau.

But America had lent a lot of money to the French and English; they had to listen politely, even if they thought Wilson was a fool.

Now, China has the money – the biggest pile of dollars in the world. And soon it will have the most powerful economy. It won’t be too much longer before Chinese leaders will want to throw their weight around. And they’ll have plenty of pounds to toss wherever they want. There are only 5 girls for every 6 boys. By the time China has the world’s largest economy, it will also have 30 million young men who cannot hope to find a wife. What will they become? Soldiers! Then, China will have the world’s biggest and most modern military…and a keen desire to show the rest of the world how things should be done.

How do you say, “We surrender” in Mandarin? We don’t know, but the Pentagon may want to look it up, just in case.

But don’t worry, that’s still a long way away…with many a slip betwixt the cup and the lip. Oh yes, China is headed for trouble too…you can’t have that kind of growth without trouble. In some ways, China is the biggest bubble the world has ever seen – bigger than dotcoms… bigger than U.S. housing…bigger than credit, finance and derivatives. Not only is it expanding rapidly – it MUST expand or it will blow up. Like a credit bubble, it can’t rest…it can’t stand still. If it stops expanding…bad things happen. In a credit bubble, people need more and more credit to service the bad loans and bad investments they’ve made. If they don’t get more money, the credits go bad. Businesses go belly up. People miss their payments. Loans get marked down. Pretty soon, you have a recession…or worse. China’s bubble is far more dangerous…because it has hundreds of millions of people who have come to depend on high rates of growth. They can’t stay where they are…they’re not peasants anymore. They’ve moved to the cities to join the international proletariat; they need work! They need progress! They need to build giant roads and aqueducts…airports and factories. They need to produce more things. They need to contribute to the global economy. They need jobs. And if they don’t get them, China could blow up. What’s more, China’s economy is run – at the very top – by officials who are even more blockheaded than our own. If trouble fails to find them; they’ll find it.

What caught our eye was a chart of China’s oil use. Ten years ago, China imported 165 million barrels of oil per year. Today, the total is more than 1 billion. What does it do with all that energy? It grows…it develops…it chugs…it thumps…it soars.

Looking at the photos (we haven’t been to China for more than 15 years), the replace reminds of a teenager – sassy, obnoxious, and outgrowing his pants. It is an adolescent nation, growing so fast it must eat all the time. In addition to the oil, China has opened 229 new coal-fired power plants since 1990.

Wonder why the price of oil hit a new high last week – above $126 a barrel? Well, China is a big part of the answer.

And rice is now selling for twice as much as did last year. Could that too be blamed on China? Well, partly. When the Chinese lived on the land, they fed themselves with what they produced. But once in town, they become more customers for the globalized market…competing for their daily bread with people in Des Moines and Dubrovnik.

You’ve heard the expression about land – ‘they’re not making any more of it.’ Well, in China, they’re actually losing it. Since 1949, says National Geographic, China has lost one-fifth of its farmland to dust-storms, desertification, pollution and urbanization. Each year, the country loses more ground – an area approximately as large as the state of Rhode Island.

Let’s see, more and more people moving to the cities – hundreds of millions of them. Building factories…building houses…buying cars…washing machines…computers… More and more people competing for the world’s resources…less and less farmland…

Oh, we’ll do the math later.

*** Today’s a holiday in much of Europe – Pentecost. Between the secular holidays and the religious ones…that is, between the sacred and the profane…it is a wonder anyone gets any work done.

But here at The Daily Reckoning headquarters, we keep our eyes open, even on national holidays.

What we saw at the end of last week was the kind of day that suits us. The Dow dropped 120 points on Friday. The dollar fell. Gold rose. And oil…as mentioned above…hit a new record.

*** And throughout much of the United States, farmers say ‘rain, rain go away.’

Often too much rain can be just as harmful to a crop as not enough. And in this case, heavy rain across the country has caused the corn crop to run behind by a few weeks. Some farmers have no choice but to plant later, causing their crop yields to go down…and push grain prices up.

An option farmers have when corn planting is delayed is to switch some of their acreage over to soybeans, but even this is becoming increasingly difficult.

Kevin Kerr explains:

“One Resource Trader Alert subscriber told me that he ’spoke to a family friend who farms a few thousand acres in Northeast Iowa yesterday, and he’s not expecting to rotate any corn to beans unless wet weather continues through this week. Even then, it’s pretty hard to get the right bean seed not to mention they’ve already fertilized for corn.’

“I heard this over and over again when I went on my spring farm tour. Farmers are locked in now, couldn’t switch if they wanted to. Input costs are so high they are even planting sections that aren’t underwater in order to just get something in the ground. At this point yields are certainly going to be impacted and there is no turning back or switching to shorter yield corn like a 90 day, or certainly not trying to switch to beans.

“In fact, I hear in some smaller rural areas seed and fertilizer dealers have been cut out and not even gotten what they were promised from their distributors, leaving many farmers without anything. This could be one of the worst years for farming in recent memory and at one of the worst times possible.”