Despite pathetic fundamentals in the US economy, America still stands as the sole economic superpower.  If you think our situation is bad, look at the UK, Europe, or Japan and their respective currencies.  It’s a bloodbath over there.

But then there is China.  As China is very well positioned to become the world’s largest exporter over the next years, the renminbi could challenge the dollar’s reserve currency status.  But one caveat remains, in that in order to become the world’s reserve currency, the Chinese government would have to float the renminbi and remove capital controls; not something we expect from the central planners in Beijing anytime soon.

In today’s Financial Times, David Woo, head of FX strategy at Barclays, had this to say about the state of the dollar:

Notwithstanding the problems with the current global reserve system, there are at present no obvious alternatives to the dollar. That said, US fiscal profligacy will push the dollar risk premium higher over time. In other words, the US’s ability to obtain cheap external funding for financing its twin deficits is likely to be curtailed. In the near term, the global economy remains too fragile to absorb the shock of a large and disorderly decline of the dollar. In that respect, the chances for coordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years.

So where does this leave you, dear reader?  How can you play a short to medium term, strong dollar?  Well, for one, hold dollars now. Or you could buy PowerShares DB US Dollar Index Bullish (NYSE: UUP) and hold it for the short to medium term.  But don’t forget about it.  The long term dollar story isn’t pretty.

Lots of data is due out this week in Australia. The big story is still with interest rates. The RBA meets on Tuesday to decide whether to leave the cash rate at its 12-year high of 7.25% or raise it.

What would you do if it were your job to set the price of money? We’d quit. It’s a fool’s errand.

The trouble is, looking at data doesn’t tell you enough to make a wise decision. If were fixing the price for a given thing, you’d look at supply and demand. But demand for what?

The obvious answer is: demand for money! The RBA released data on Friday showing that demand for credit is growing less fast. Housing credit grew by less than a tenth of a percent and business borrowing didn’t grow much either.

Isn’t this a good thing? By raising the price of money (with the cash rate) the RBA has reduced the growth in demand. You can’t spend what you haven’t borrowed. However, keep in mind that overall demand for credit is still growing. Housing credit grew by 9.5% in the last year. And demand for all credit grew by 14.1% since last April.

That is not exactly a slump, is it? So what should the RBA do? It can wait for the GDP figures to come out later this week. Those will probably that the economy is growing at less that 3% a year, while inflation is still running above 4%. How can you still have rising prices with slower economic growth? It reminds us of the old U2 song, running to stand still.

Well, here’s one possible answer: the RBA can influence the demand for credit in Australia, but it cannot influence the demand for Australian resources. It’s careful formula for calculating the price of money is ruined by a variable which is beyond its control. Don’t you hate it when that happens?

A month or so ago, we pointed out that that higher prices for coal, iron ore, and bulk commodities were leading to record favourability in Australia’s terms of trade. That is a problem for the RBA. To read up on what the Terms of Trade are, check out this article: http://www.dailyreckoning.com.au/terms-of-trade/2008/04/18/

When the terms of trade improve (you get more money for what you sell and pay less for what you buy), you have money flooding into corporate and eventually, personal coffers. That money can be accumulated as cash balances by corporations. Or, it can create wage pressure in the economy. And remember, unemployment is at 33-year lows. There is already wage pressure.

It’s not that complex when you break it down. With the resource sector booming, the increase in activity and terms of trade is highly stimulating. Foreign demand for Aussie exports directly influences domestic demand in the form of wage pressures. What can the RBA do about that?

Frankly, we’re not sure it can do anything. We’re even more sure that global central banks are either unable or unwilling to take steps that might lead to a lower oil price. Hiking rates would slash global economic growth, and inevitably lead to lower oil demand. And there’s also the fact that the oil price—like all commodity prices—is closely correlated with money supply growth.

Cut the growth in broad money supply and you knock at least one leg out from commodity prices. But after a week of watching the noxious garbage on CNBC, we find it hard to believe the U.S. Fed will be raising rates any time soon. Wall Street would raise a hue and cry like it did in August of last year. The ECB might raise rates just to show it can. But it’s unlikely.

We’ll keep our eye on the data. But after a week away from the markets, it doesn’t look to us like much has changed while we were breathing the clean air on the Continental Divide. Congress here in the States wants to investigate manipulation in the oil market, while ignoring the government-sponsored manipulation of the currency (managed decline). Morons.

Australia is firmly ensconced in its spacious corner of global prosperity. You know though, after spending a week here in Colorado in our old stomping grounds of Estes Park, America seems cheaper by comparison. Everything is cheaper here….petrol, food, clothes, and even coffee (although American coffee is weak by Australian standards). Hmmn.

Haircuts are up though. Our old barber Carol Dermody has been cutting our hair since we were just five years old. There was more hair then, and in 1980, the old flat top hair cut was just $5.

Carol is a hard money man. He wears a bolo tie with an old silver dollar as the knot. Because he believes in real money with a stable, relatively unchanging value, he hasn’t hiked prices to keep up with inflation. Haircuts are $12 now.

We’re in the States for the rest of this week, but will be reckoning for you each day until we get back to Melbourne on Sunday. Until tomorrow…

Dan Denning
The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Source: Demand for Credit is Growing Less Fast

Economists expect the gross domestic product to be revised up to 0.9% in the first quarter, from the initial estimate of 0.6% when the government releases the data on Thursday morning.

However, many economists aren’t so sure that the ailing US economy is out of the woods yet. They argue that the toughest times may even come next year until the impact of the economic stimulus wears off.

“The cold shower will come when they realize [the pop] from the stimulus was just temporary and there are a lot of big fundamental problems and growth is just going to fade away in the fourth quarter and first quarter of next year,” says Nigel Gault, chief US economist at Global Insight, quoted in the report.

“The economy needs more than a jump start to get it going. The engine has too many problems to kick into gear until the middle of next year at the earliest.

William Patalon III says the bearish case for the US economy is strong and has just got stronger following a prediction of a major lending pullback by Oppenheimer & Co analyst Meredith Whitney.

“Whitney’s reputation has soared like a skyrocket since she made her bearish — but highly prescient — call on the banking sector, including Citigroup.

“Now she’s back. And her outlook for the financial sector is actually worse. Whitney is now predicting that the banking-sector’s financial crisis will extend well into next year. If not beyond.

And that’s not even the bad news.

Whitney now says the worst may be yet to come. The banking-sector financial crisis will last at least until the end of next year, and may actually stretch well past that. And that could lead to a major U.S. downturn.

“’We believe the credit crisis is far from over,’ Whitney wrote in a research report last week. ‘In fact, we believe what lies ahead will be worse than what is behind us.’

The so-called ‘first wave’ of the credit crisis hit banks’ trading books. But the second lightning strike will hit lenders where it hurts the most — right in their lending businesses. If she’s right, the impact on the economy will be devastating.”

Apparently, the US economy grew by 0.6% year-on-year in the first three months of 2008. It’s not great, but it’s not a recession. Meanwhile, jobs data on Friday showed that there were just 20,000 job losses in April, against expectations for a 65,000 fall.

So has everything been blown out of proportion? Was the credit crunch really just a storm in a teacup?

It’d be nice to think so. But let’s take a closer look at those figures…

Why we shouldn’t rely on GDP figures

I don’t tend to pay much attention to GDP figures when they come out. And there’s a good reason for that. They’re not really worth the paper they’re printed on.

Both here and in the US, GDP figures are subject to substantial revisions, long after (we’re talking years) they have first been published.

So while the estimate of 0.6% growth for the US in the first quarter of this year might look fine just now, as US fund manager John Mauldin puts it, “my bet is that the numbers for GDP will be revised down when the economy is well on the way to recovery… That is what happened when we found out a few years later that the last recession started in the third quarter of 2000. The initial numbers were positive.”

Another interesting point that Mauldin makes is that the inflation figure used to calculate the GDP figure is very forgiving. The US Government department calculating the GDP figure reckons that inflation was 2.6% during the first quarter. With nominal growth at 3.2%, that gives the ‘real’ GDP figure of 0.6%.

But if you take the official ‘headline’ measure of inflation, which came in at more than 4.1% during the first quarter, then ‘real’ GDP growth would quite clearly be negative.

It’s not to say that this is all a massive conspiracy to keep people in the dark about the true state of the economy. But clearly there’s an incentive for governments – any government – to present the most forgiving figures they can. And that’s bound to have some effect on how the figures are put together.

US jobs data deserves a closer look too

As for the jobless data, delving into the make-up of these is another eye-opener. You see, the jobs data in the US isn’t just a simple measure of the real number of jobs being added to the economy. There’s an additional quirk called the birth/death ratio.

What’s this? Well the employment survey goes around established businesses. But it can’t hope to pick up on all the small businesses in the country and the hiring and firing that they do. So an estimate for the number of jobs small businesses add to the economy is thrown in.

This works fine most of the time. The trouble is, as both Mauldin and regular MoneyWeek contributor James Ferguson point out, that it all falls apart at turning points.

The birth/death ratio is based on historic trends. Right now, a historic growth trend is ending, and turning rapidly into a downturn. However, the birth/death ratio hasn’t picked up on that yet.

In fact, this April, the birth/death ratio added more jobs – 267,000 – to the labour survey, than it did last April (262,000). As Mauldin points out, this included 45,000 jobs in construction, even as the actual survey showed construction job losses of 61,000 at established companies. There were also 8,000 jobs added in the finance sector, and 83,000 in the hospitality sector.

“Without that addition from the birth/death number, total private employment would have dropped by 296,000… when the final revisions are in, we shall see that job losses were well south of 100,000,” reckons Mauldin.

Again, the birth/death ratio isn’t part of any government conspiracy to keep us all in the dark. It’s just a statistical smoothing device that ceases to function properly when the economy reaches a turning point. It’s over-estimating the number of jobs being added today as the economy turns down, just as it under-estimated the strength of the job market back in 2003/04 when the economy started to come out of recession.

And none of this is obscure information. Analysts and investors should know all this, so it’s odd to see the market responding at all to these figures. But then, as I’ve said a few times, we’re still in ‘glass half-full’ mode.

How oil prices could hurt the UK economy

But make no mistake, that won’t last. With oil prices breaching $120 a barrel, the Ernst & Young Item Club has warned that it may have to slash its UK growth forecasts for next year. The group suggested that if oil prices remain this high, inflation will remain above 3% for the next three years. And if oil hits “$200 per barrel, as one Opec minister recently predicted, then frankly all bets may be off,” said Hetal Mehta of the Item Club.

That $200 a barrel seems extreme. But then, $120 a barrel seemed extreme only six months or so ago. There’ll be more on oil prices from my colleague Dominic Frisby tomorrow, but suffice to say, even if prices don’t get much higher for the moment, the Bank of England is going to have a very decision to make on interest rates on Thursday.

Editors Note: This article was published in Money Week May 6, 2008