Mr. Dodd, a man who pontificates on any and every subject under the sun and never lets real knowledge of a particular subject area stand between him and the nearest microphone decided to try out the “N” word – Nationalization! Traders viciously dumped the dollar on Dodd’s “deliberation.”

Dodd Speaks, the Dollar Sinks

And of course the games continue!

The dollar was sharply lower on opening in Asia last night with nationalization of U.S. banks ruling the headlines. But of course the U.S. isn’t the only one flirting with bank nationalization. Take a second look at Europe and Japan (and just about anywhere you care to look) and it’s ugly!

The euro has already reversed 200 pips from its high overnight, likely due in part to Mr. Trichet’s weighty assessment that Europe’s financial system is under huge strain. I say weighty because one should never confuse Trichet’s statements with anything dribbling from the constantly flowing font that is Dodd.

We were of the opinion U.K. banks would beat others to the race toward complete bank nationalization. But it’s probably splitting hairs as de facto nationalization seems the order of the day. Why buy financials in your 401(k) when you own them anyway?

I used to tell people that currency analysis was like being the judge at an ugly contest – the least ugly wins. But now, there is little that separates the degree of ugliness among all competitors. Thus, we have gold printing over US$1,000 and who knows where from here.

Gold has soared against the euro, pound, Aussie and U.S. dollar; though it hasn’t made a new high yet against the buck.

Gold Has Already Climbed Against the Aussie, Euro, Pound and Buck

We’re still sticking to our story that the world reserve currency will be buoyed at a time like this. But I have to admit that I’m covering my eyes when I see the U.S. government’s supercharged attempts to spend its way out of a debt deflation…ugh.

Replacing public debt to the same or increasing degree in which private debt is written down (public debt really means private debt because the private sector does all the wealth creation – while government mostly destroys it trying to “help” us) is no way to allow the system to cleanse.

But with pontificating pandering politicians never more than two minutes away from a microphone, we seem to be stuck there. And I have to wonder why we aren’t seeing any “traction.” Is it to cry, or maybe time to buy more gold? Maybe both!

Source: Only Gold Is Winning the Ugly Contest

This from Sovereign Society:

Think back to the beginning of 2008. If you’re like most investors, you were probably wondering just how low the dollar might fall in 2008, and how much higher oil would surge. But, Mr. Market surprised us in a big way in 2008.

Now the question seems: How much higher will the dollar go, and will oil continue to plunge lower?

Many were so surprised by awesome and swift change of fortunes in 2008. So let’s take a look at some of the reasons for the swift reversal of fortunes for these two major asset classes. There are solid fundamental reasons why the oil-dollar relationship has been so tight, and will likely continue in 2009.

The Secret to Currencies: It’s About Money Flow

I’ve had an opportunity to talk with a lot people about currencies this year. And the most asked question by far is this: How can the dollar rally when the U.S. economy is doing do poorly, to say the least? It’s a good question. Let me explain.

One of the things you must always keep in mind when dealing with currencies is this: The price of a currency is determined by the currency’s supply and the demand for that currency. It is that simple!

Though it can get complicated when we go through all types of analytical gyrations in order to figure out exactly where supply and demand sit. Now, think about the credit crunch. It was a sea change event in the global economy that completely altered the supply and demand dynamics for every single asset class — stocks, bonds, commodities, and currencies.

Let’s look at how these key asset classes acted together during the last market cycle, i.e. before the credit crunch changed everything. If you examine the chart below I think you will see that one key asset class — the dollar — didn’t play well with others. It went down as the other asset classes went up.

The chart below is a bit convoluted, I know. But, it is important to understand because it helps explain how money flow is critical to forecasting the dollar’s path. As you can see below, the dollar index tended to travel in the opposite direction of gold, oil and stocks before the credit crunch hit the global markets in 2007.

Before the World Had Heard of a “Credit Crunch”

2001 – 2007: Gold, Stocks and Oil Hit Multi-Year Bull Market. Notice that each of the asset classes, except the dollar, launched into a multi-year bull market back in January 2001! Back then, Fed, European Central Bank (ECB), and Bank of Japan (BOJ) all juiced the markets with liquidity. At the same time, investment banks added even more liquidity by creating literally trillions of dollars in new derivatives.

Think of this era as a dollar-based liquidity explosion for all asset markets except for the major funding source for all this growth: the U.S. dollar.

Fast Forward to 2008: Now, let’s take a look at this same chart after the credit crunch hit the global markets in 2008. The dollar (red line) bottomed the week of March 10th, then gold (brown line) topped at the same time. By then, stocks (blue line) had already topped. A few months later, oil (black line) also topped in July.

We Watched Gold, Stocks and Oil Top Out While the Dollar Surged

What happened? Why the big change? Money flow! Money poured back into the U.S. as the impact of the credit crunch forced major institutions to deleverage their positions.

The big players were (and still are) fighting for their lives. They had to sell risky asset investments overseas and bring money home. And we’ve also witnessed big repatriation of retail mutual funds back into the United States. In four months thru October 2008, U.S. residents sold a net US$126 billion of foreign securities.

So, this is why it didn’t matter that the U.S. economy was in the tank and getting worse. Money flowed back into the dollar because of the credit crunch! Remember, it is supply and demand.

We had, and continue to have, a situation where the supply of dollars (in the form of trillions in dollar-based derivatives) is evaporating. In other words, we’re seeing a lower dollar supply worldwide. At the same time, we’re seeing a massive decline in global demand as all the major economies are entering what could be a very deep recession!

Where Are We Headed in 2009? Another Big Surprise in the Making!

Unfortunately for most people, I expect global economic conditions to get a lot worse in 2009 before they start getting better. Why do I say this? Because global trade and demand has vanished at an astonishing rate and seems to be accelerating downward.

Consider these facts:

1. In November, Japan recorded the biggest single decline in exports ever; back into a nasty recession and deflation they go!

2. China exports declined in November for the first time in seven years; unemployment is soaring as factories close everywhere in the country; the export model is in jeopardy; social stability is paramount in China at the moment.

3. Global marine shipping rates have fallen up to 95% and more.

4. Plunging energy prices have eviscerated the Russian economy so the government is now draining reserves; major social unrest is in the cards.

5. Spain is in panic mode — ditto for Ireland, Italy, Greece, Portugal, and other members of the European Union.

6. Germany (the engine of euro growth and model of fiscal discipline) is heading into deep recession — latest consensus forecast is 2.7% decline in their economy.

7. The U.K. economy is staring into the abyss; and it looks to get worse.

8. Credit for emerging market nations has virtually disappeared. Export demand for their goods has vanished. They are relying on emergency International Monetary Fund (IMF) loans as a stop-gap measure, but the IMF tap has its limits.

9. The U.S. consumer has finally stopped shopping and is saving. That’s a good thing long-term for capital creation, but it’s a disaster in the short-term because the U.S. consumer is the catalyst for global demand and rising unemployment means no rebound by Mr. Consumer anytime soon.

Governments are pumping up money supply, cutting interest rates, and spending taxpayer money as fast as they can, but it doesn’t seem to be helping much.

This tells me that the major market deleveraging will have to run its course before economies begin to respond. And in a deleveraging phase, as I showed you above, the dollar (the world reserve currency) tends to do well…or at least be supported.

But there is another major surprise on the horizon that I believe will lead the dollar to its next big rally phase — concern that the European Monetary System, which represents the euro currency, will come apart!

The euro is the key currency competitor against the dollar. When the euro does well, the dollar does badly, and vice versa. But as global demand continues to shrink, I expect key member countries — either Italy, Greece, Ireland, Portugal, or Spain — to completely abandon all fiscal responsibilities they must maintain as members of the European Monetary System. And that will hurt the euro.

It makes sense, and here’s why.

Euro Member countries have no sovereignty on monetary policy. That is set in Brussels by the European Central Bank (ECB). And the ECB is woefully behind the interest rate curve. And the big member country — Germany — is railing against providing a major stimulus to support the rest of the union members. Why should Germany pay for other countries lack of discipline?

This is the Achilles Heel of the European Monetary Union — Since member countries have no fiscal responsibility, they can spend all they want and the ECB has no say or power to stop them. They can also spend, as little as they want if it suits their citizens’ needs. In other words, there is a lack of political sovereignty behind the key member states that form the Eurozone, and back up the euro.

In an environment where most countries — and their politicians — are scrambling desperately to provide stimulus to their citizens, I expect several member countries in Europe to abandon their Brussels-based fiscal shackles and break the bank.

If that proves true, it will rattle the foundation of trust and cooperation the euro was supposedly built upon. Trust and cooperation work fine when everyone is making money and growing.

But in the dark days of a downward business cycle, with the wolf at the door, it’s everyone for himself. This is the first major test of the euro as a currency during a major down cycle.

Don’t be surprised if it fails. And if it does, it would be very bad news for the euro and would usher in a whole new wave of money flowing to the U.S. dollar — a wave more-than-likely to trigger a powerful leg up in the greenback.

The Next Direction for the Dollar…

It should be an interesting year. But once again, I’m betting the dollar will rally. Be prepared.

Source: The Dollar: The Biggest Surprise Currency Of 2008… Plus, What’s Coming In 2009

“Today might be the day that marks the beginning of a legitimate U.S. dollar correction,” wrote Jack Crooks, president of Black Swan Capital.

“We’ve been open to this potential for the last several weeks, as we think a lasting correction is due before the U.S. dollar can start on its next powerful leg of what we are expecting could be a multi-year bull market,” Crooks said.

With the election finally over, many analysts are saying the result isn’t likely to be a major driver for currency markets.

“Implied volatility has continued to fall, suggesting the euro could move higher in coming days with market participants likely to look past today’s U.S. presidential elections toward what could be horrendous jobs numbers on Friday,” wrote currency strategists at Brown Brothers Harriman.

The euro surged despite near-universal expectations that the European Central Bank will cut interest rates on Thursday. Also predicted for Thursday is a cut in British rates, but the pound rallied anyway, as well.

Source: Dollar is Hammered

This from The Sovereign Society:

Put simply: If things don’t start improving quickly in South Africa, it’s poised to become the next – and perhaps most noteworthy – failed state in all of Africa. Think Zimbabwe, but multiply the chaos as South Africa has long been the best and last hope for Africans striving to build and maintain a modern and efficient market economy.

1. Global economies, most specifically emerging global economies, have been brought to a halt by declining levels of demand. South African resources are particularly exposed to demand destruction as the global recession spreads. Frozen credit markets have tied the hands of economies once turning heavily to South Africa for its natural resource production.

Declining commodity prices alone will certainly send tremors throughout South Africa. Accessibility of credit will put a damper on new South African projects, and sharply lower commodity prices will make such projects increasingly less profitable.

This ultimately means a severe drop off of capital inflows. Up until this point, South Africa’s appealing growth story was still in its infancy.

The country made hay off the commodity bull market and South Africa’s currency is stamped with a fairly attractive yield. But the collapsing global financial system will stop South African growth dead in its tracks. At that point we’ll learn just how improved the booming global economy allowed South Africa to become.

Unfortunately, there are plenty of pieces that still don’t fit together. To that point…

2. Political and social unrest has frequented the African continent. Though South Africa is considered a democracy, it’s effectively a one-party state ruled by the African National Congress (ANC). Political and social pressures are quickly encroaching.

The ANC is a Marxist-like organization that has aggressive redistribution policies. It has instituted a draconian affirmative action program to increase black employment. But this has led to massive incompetency in key sectors of the economy and a “brain drain” out of South Africa.

The reality is, unemployment for many black workers in the townships has not improved much at all. And these efforts to empower more nonwhites will likely unwind dramatically as the economy deteriorates like it did a decade ago.

In fact, life of squalor and poverty for many South Africans has gotten worse over the past several years. Social stability has spiraled downward and crime is rampant throughout all levels of society. But because the poor don’t have the wherewithal to hire private guards, they are victimized repeatedly by roving gangs of thugs. It is a sad awful existence that has not improved despite the ANC guaranteeing it would.

And as the business cycle turns down, we expect the ANC to try to ramp-up its efforts to redistribute wealth in an attempt to damper rising social unrest. The impact of which will only hollow out South Africa’s economy even more, further weakening what once was a vibrant and efficient economy.

Given these items, we think the South African rand is extremely overvalued. It represents a crisis currency in the making. This is truly big game territory. For when the market finally recognizes this country’s deep and profound economic, political and structural problems, South Africa’s currency will face a world of pain.

Source: Markets Sink Again, and Best Opportunities Still Reside on the Short Side…

This from The Sovereign Society:

You know by now that emerging market currencies are like bodybuilders on steroids.

When they get their fix of liquidity (capital flowing in) they are very powerful and outperform the major currency block by a wide margin. But if their source dries up, just like a junkie, they quickly lose strength and can crash and burn.

Among emerging Asian currencies, the Thai baht appears most exposed to global market conditions, most vulnerable to the crash-and-burn scenario. Keep in mind, Thailand was ground zero for the Asian Financial Crisis back in 1997-98. It has history. And history is bound to repeat itself!

As recession digs in across the developed world, demand is swooning. This trend is already being reflected in the price of commodities. Crude oil, specifically, has plunged like a refrigerator off a high-dive. And demand in the developed world is set to taper off even further.

Simply put: Sinking demand is very bad news for the emerging market world, especially Thailand where 70% of their gross domestic product flows from exports.

And if you’re wondering what country is the largest single importer of Thai exports, look no further than the United States. It’s safe to say Thailand is as tied into the global slowdown as anyone.

Estimates had been calling for export growth, in dollar terms, of 15-19% in 2009. But wait – scratch that. The Thai Chamber of Commerce now expects only single-digit export growth next year. Annual export growth collapsed from July to August, falling from 43.9% to 15.5%.

And that’s just the beginning of the story for Thailand…

Instability Bringing Thailand to Its Knees

Until lately Thailand had been suffering from surging inflation and a central bank scared to take action. Annual price growth ran as fast as 9.2% in June.

But since global demand has self-destructed and crude oil prices have sunk considerably in recent months, the inflation rate in Thailand has eased to the 6% range.

Still, that’s not so healthy. But the fact that core inflation is moving down towards more comfortable levels for the central bank means their focus is shifting towards maintaining growth. The impact of the global credit crisis on Thailand’s economy remains to be seen. But it’s no stretch to expect disappointing numbers once the dust settles on this global meltdown.

But falling growth will exacerbate already high political tensions, and vice versa.

Protests between supporters of the previously ousted government and its opponents have already prompted a State of Emergency. It has since been lifted, but the government can only hope the situation doesn’t escalate again.

We just learned that the previous Prime Minister, Thaksin Sinawatra, was sentenced to two years in prison for fraud. What this does is bolster protestors’ attempts to oust the current government, the People Power Party.

If government officials are preoccupied with the growing political crisis, then they will be distracted from mounting economic pressures. And oddly, mounting economic woes have a way of increasing political tensions because people naturally seek scapegoats for their problems.

Needless to say, the thought of yet another change of government is reason enough for foreign investors to flee Thailand. Mix it with a deteriorating export market and you’re shaving at least a percentage point off of GDP, possibly more.

Can you say capital flight? We think it comes soon.

Our sole Thai baht trade has produced 220% gains in about 2 ½ months. We expect many more profitable trades on the baht as the crushing reality of a global recession weighs on the export-dependent currency like a boulder.

Source: Poor Earnings Sends Stocks Tumbling Again…Yet “Unexpected” Strategy Provides Four-Digit Gains Despite Historic Collapse of Global Stock Markets

This from the Sovereign Society:

Again, it’s a problem of dependence. The Czech Republic is highly dependent on growth and financial market stability across the Eurozone. The major countries of Europe represent the key export markets and the financial institutions funneling foreign direct investment into central European countries. But now, both growth and financial stability in the Eurozone are being turned upside down, shaken, and dropped on their heads.

The needier countries of central Europe have benefited mightily from cross-border investment. As big players in Europe carried the region to greener pastures, the Czech Republic put a great deal of confidence in Europe’s financial system. Too much confidence, in fact.

Foreign banking institutions control an estimated 60-80% of all banking sector assets in the CR. But now – almost tragically – these foreign-oriented banks are scrambling to stay afloat. Credit in the financial system is evaporating in a hurry. And, in turn, so is the economy.

Concrete evidence that the Czech Republic is already flying off the tracks remains to be seen. And even though we can’t yet point to anything “wrong” with the CR economy – things like sky-high unemployment, runaway inflation, massive deficits, etc. – we can look to the future. And that’s where the outlook gets nasty.

Sure the Czech Republic has been a real star in Central Europe, as the government is privatizing and cutting taxes. But don’t be fooled – that star has already begun to fade… and fast. Economic growth is tapering off rapidly from its plateau two years ago. GDP growth touched nearly 7% in 2006. Now it’s got a date with 4%…and very easily could be less than that.

Czech Republic GDP Growth Is Slowing

Source: KBC

CRs current account deficit will surely increase as foreign direct investment fades and exports feel the crunch that’s bringing the rest of Europe to its knees. Unfortunately for CR, domestic demand simply isn’t sturdy enough on its own to sustain levels of GDP we’ve become accustomed to seeing out of CR the last few years.

And that’s just the economic gloom peeking over the horizon. It gets worse when you consider the potential for a geopolitical storm set to blanket the country…

Geopolitical Risk Is Bad for Currencies

A lot of issues may be running through our heads amidst the economic turmoil and chaos leading up to the November U.S. Presidential election. But it helps to understand that the political climate across the European continent isn’t exactly peachy. And the rising pressures between Russia and NATO have the potential to turn very sour, very quickly.

As has been the case throughout history, Central Europe can become a buffer zone between Russia and Western Europe in the blink of an eye. Favorable economic positioning? I think not. This certainly makes for an unattractive investment destination.

Competing factions within the Czech government are concerned about aligning too closely with the U.S., and becoming its “defense shield” in this dispute. Tension is most certainly brewing. And this geopolitical instability in the region comes at a time when economic concerns require everyone’s full attention. A resurgent Russia is a wet blanket to the vital foreign direct investment flow on which the Czech Republic – and Central Europe in general – so highly depend.

There are plenty of financial victims these days. In this particular instance the Czech koruna is the victim. In the CR, economic growth is applying the brakes, country finance and foreign direct investment are set to deteriorate quickly, and geopolitical risks are rising. That’s a miserable combination for any country’s currency.

Shorting the Koruna:
Like Riding the Euro Downward, But Only Twice as Fast

The reality is that Central European currencies in general are very much a euro story.

There’s no getting around that, especially at this point in the global economic cycle. As the euro goes, so goes the Czech koruna.

The difference is this: The koruna moves up and down more than twice as fast as the euro when you compare each against the U.S. dollar. In other words, it’s like Wrigley’s Doublemint gum – double your pleasure, double your fun…
And double your profit potential while you’re at it!

Since 2000, the Koruna Has Soared Against the U.S. Dollar.
Now It’s About to Reverse with a Vengeance!

In the chart above, the Koruna-USD pair is quoted in koruna so the falling line in the chart means it took less koruna to buy a U.S. Dollar. That is, the falling line is the same as the U.S. Dollar falling against the koruna. Now that’s reversing and the dollar is rising vs. the koruna.

We believe the U.S. dollar has bottomed versus the euro. And a dollar bull market rally (euro bear market decline) is now underway. If you’re ready to hop on board at the beginning of an earth-shattering trend, you can look past the euro. It will be even more profitable for you to ride the Czech koruna lower against the dollar.

Those holding Czech koruna during the dollar’s seven-plus year bear market took a 250% rocket ride higher. A lot could happen in seven years, sure, but we say now’s the time to get positioned and stay positioned.

Our one koruna trade so far is up approximately 940% in just under two months. We expect many more opportunities for profitable trades as this currency’s long-term down trend intensifies.

Source: Capitalism on the Ropes!

This from the Sovereign Society:

If we had to pick a “looking in the other direction” favorite, I guess it’s the good old Swissie.With the eurozone breaking down in a big way, Switzerland — though not setting the world on fire and still smarting from the reality that Swiss bankers don’t seem to be able to control risk any better than anyone else — seems as though it might garner some money flow from the ‘zone and Central Europe.

Swissie Trade Points to Profit with a Glowing Exit Sign

It appears the selling pressure is waning, evidenced by the decline in selling volume in the Swiss futures listed on the CME…

Perhaps a higher dollar and Swissie are two of the few positive developments rising out of this economic mess.

Source: Dollar Bull Trudges on, Swissie Points to Quick Profit

What most people just don’t get, says Chuck Butler is that the bailout “constitutes the single greatest case of ignoring the free market in modern history.” And there is actually little justification for it.

“On a historical basis, many parts of the US economy are in awfully good shape,” according to Chuck

This from The Sovereign Society:

We’re told to believe otherwise because doom and gloom dominates what the mainstream media consistently reports.

One of the biggest fear indicators they use: Employment numbers. After all, Americans don’t want to lose their jobs.

But look at the current employment situation on a historical basis: While U.S. job losses are on the upswing, they are fairly modest … and should be expected in a self-cleansing market.

As my chart shows, taking into account only the last 40 years, today’s unemployment rate sits relatively low compared to 1975, 1983, and 1993.

If we play our cards right we could see the current rise in unemployment top out around the same levels as it did roughly five years ago. That would be nothing to panic over.

Let’s look at inflation – another economic boogeyman…

Current CPI in the U.S. sits just north of 5%. That’s easily less than the roughly 6% to 7% back in 1991. And in 1980, for example, inflation reached almost 15%.

Countries, particularly emerging markets, would kill to have inflation as LOW as 5%!

More to the point, Americans can afford necessary food items as easily as ever. Here’s a snippet from an article put together by the Federal Reserve Bank of Dallas last month:

Based on the average U.S. pay rate, it takes less than two hours of work to pay for 12 basic food items – tomatoes, eggs, sugar, bacon, milk, ground beef, oranges, coffee, lettuce, beans, bread, and onions.

That figure is nearly as low as it’s ever been.

Consumption may finally be taking a breather, as it should, but discretionary items like computers, DVD players, cell phones, digital cameras and color TVs have become far more affordable. And that even includes those families considered “poor.”

Moreover, despite my view that the U.S. government is dipping its hand way too deeply into the markets, making them increasingly less free, it’s all a relative game.

Many other countries around the world are either officially in, or about to slip into, recession.

And on a relative basis, because their governments are much more entrenched in the market than Uncle Sam is in ours, their ability to recover is hampered even more.

Why is this an important part of the dollar equation? Because it means that, despite all our warts, it’s quite possible the U.S. might still win the global economic beauty contest by getting judged the least ugly.

PS: There are massive changes in store for the world economic system, and currencies will be the battlefield where this change actually takes place. Join Jack as he explores one of the most profitable sub-niches of the currency world and explains how to turn those changes into triple-digit profits. Click here to find out more.

Source: What Could Have Been a $700 Billion Slap in the Face

So instead of analyzing this unpredictable marketplace or trying to read Paulson’s mind, we’re going to review a week that will no doubt go down in history. In so doing, we’ll develop a better understanding of the moral implications of the past week’s events.

Week in Review: One for the History Books

If you have money on the line right now, then you know it’s been a less-than-pleasant week of trading. We had one of the largest point losses in Dow history followed by a 200-point gain in the very next session. There have been more swings than you could find on the neighborhood playground. But there’s also been a steady – if not growing – sense of worry.

At the heart of it all, there has been an equally steady stream of intervention hoping to relieve such concerns.

If you didn’t have a chance to keep up with how things played out from day to day, let me do a quick and dirty recap:

Sunday: The Federal Reserve pumped a bunch of money into the system, increased how much it will provide in lending facilities and further liberalized the collateral it will accept in exchange for loans.

Monday: Lehman Brothers declared bankruptcy. Bank of America took control of Merrill Lynch. And AIG’s fate hung in the balance.

Tuesday: The Federal Reserve denied the markets a much anticipated interest rate cut. Instead, it followed with a two-year, US$85 billion loan to bailout AIG (NYSE:AIG).

Wednesday: The Treasury announced a finance program where it would auction off Treasuries, separate from what it already offers. The proceeds will go to the Federal Reserve to use for “initiatives.”

Thursday: Central banks around the globe decided to join the party. They declared efforts to pump nearly US$250 billion into the global system to avert a financial train wreck.

Friday: We learned of a new initiative, spearheaded by Treasury Secretary Henry Paulson, to put together US$800 billion in a new-fangled institution and US$400 billion more at the FDIC. The money will be used to take crappy assets off troubled balance sheets and grease up money markets.

Sunday: We heard some of the nuts and bolts of Paulson’s plan as he ran the talk-show circuit, and we waved goodbye to the Independent Investment Bank. That’s right, Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) will play a pivotal role as “Bank Holding Companies” in Paulson’s new plan.

Prior to this week, steps taken to stabilize the market were considered ineffective. By the looks of it, though, this week’s actions tell me these guys don’t want to fail in their efforts to restore order…again. But the condition of credit markets is far from cured.

Plus, there’s another issue that the Fed and Treasury might have to wrestle with down the road…

Moral Hazard: Don’t Worry, We’re Too Big to Fail

“We cannot protect all risk in the market, and we should not do it at the risk of the taxpayer.” – Richard Shelby, Alabama Senator

“Moral Hazard” is a pair of buzz words circling lunch tables, office cubicles and board rooms around the world. Why? Simply because the Fed and Treasury are taking matters into their own hands, trying to put an end to the losses wreaking havoc on the global financial system.

And in doing so, our government could be seen as endorsing the reckless lending that led us to this disaster in the first place.

However, what scares me most about these interventions is that some could create a humongous burden on the taxpayer.

The two-year US$85, billion loan from the Fed to AIG this week is an attempt to provide a controlled environment to deal with the pain, spare the financial system from the effects of extreme counterparty risk, protect the real economy and keep the bill off the taxpayer.

So what if the burden of this financial mess doesn’t end up in the taxpayers’ lap? Could there still be moral hazard?

Good question.

Because what kind of precedent are they setting? These are banks and institutions that took on toxic derivatives and securitized debt. They fattened up when times were good, but come crying for help now that the going has gotten tough. How many more will follow expecting the same treatment?

Perhaps this is the real issue.

JACK CROOKS, Editor of World Currency Options and The Money Trader

Source: In a Single Week, America Sails into Uncharted Moral Territory

Producer prices are simply the costs required to produce goods and services. Naturally, when producers have to pay higher costs to produce goods, they’ll demand higher prices for the goods they’re selling. In other words, they pass their higher costs to you, the buyer.

Rising commodity prices tend to be a big reason why producers’ costs rise. More money spent in production means smaller profit margins at current prices. If a producer wants to make up for shrinking profit margins but can’t control his input costs, then he must pass on these costs in the form of higher prices. Excess money creation is what drives this type of inflation, affording higher prices.

No doubt, this is exactly why rising energy costs have been such a huge driver of the inflationary environment we’ve trudged through over the last several months.

The debate is heating up among whether this global inflationary period is coming to an end. I tend to believe it is. But, more importantly, economic growth and available credit across the globe is rolling over at the same time surging commodities have left inflation concerns on everyone’s mind.

For this reason central bank policy makers are struggling.

The cost of energy has buoyed the cost for producers, consumers, and everyone in between. But what happens when this pressure eases for a considerable stretch of time?

Inflation Is a Little Bit Different on the Other Side of the Pond

They don’t serve ice cubes in their drinks. They can drive on the left-hand side of the road. And inflation is also a little bit different in Europe. Despite this fact, inflation analysis in these respective regions often focuses on generalities and overlooks one particular difference. Let me explain…

Let’s focus only on two countries and two central banks: The Federal Reserve and the European Central Bank. If you haven’t been hiding under a rock for the last year, then you probably have some kind of idea how their respective policies vary.

The Federal Reserve has knocked off more than 3% from its benchmark interest rate in the last year. In that same time, the European Central Bank has mostly stood its ground, mixing in one rate hike of 25 basis points that brought its benchmark up to 4.25%.

And if you’ve been following my currency articles lately, you also probably know that this monetary policy discrepancy has been a boon to the euro and a detriment to the buck. For many months, even years now, the relative performance of each currency has been primarily based upon expectations for this rate differential to change.

As you might imagine, inflation expectations play an enormous role in monetary policy expectations. Even though inflation has received plenty of attention over the last several months, many analysts have neglected an important difference between European inflation and U.S. inflation.

Now’s the time to pay closer attention.

What All the Analysts Have Missed Over the Last Few Months

In the last few weeks, commodity prices (particularly crude oil) have cracked. With that abrupt downturn also came a reprieve in inflation expectations. And that’s got many accepting the potential for a lasting shift towards even lower prices and less inflation pressure.

With that in mind, the dollar has managed to rally on two simple facts:

1. The U.S. Federal Reserve has already lopped off a considerable portion of its benchmark interest rate. So they’re now ahead of the rate-cut curve, which has helped maintain some growth in the U.S. relative to Europe.

2. The European Central Bank will be forced to bailout their deteriorating economy by cutting their benchmark interest rate.

Up until this point, the European Central Bank had a good reason to keep fighting inflation. But with commodity prices easing up, now may be the time for ECB policy makers to take action. Here’s why they’ve struggled…

Why Hasn’t the ECB Joined the Worldwide Rate Cutting Party Yet?

With many threats to global growth and concerns over several eurozone member countries, many have been surprised the ECB has gone so long without letting up on the interest rate front. After all…

• The Federal Reserve has made several moves to lower rates
• The Bank of Canada has followed suit
• The Bank of England has gotten the ball rolling
• So has the Reserve Bank of New Zealand
• The Reserve Bank of Australia is likely next

If you’re wondering why the ECB hasn’t budged, look no further than labor unions. Simply put: Wage contracts put in place via labor unions have employees’ wages moving higher in lock-step with inflation.

There’s really no thought to profitability (the point when workers typically consider demanding higher wages). In other words, rising headline inflation fuels this wage-spiral. And this wage-spiral spurs greater headline inflation. And it continues on like this. That’s something Ben Bernanke hasn’t had to deal with.

You see, the Fed has been able to react to weakening growth by cutting interest rates. The plan: As growth moderates, or rolls over, inflation is likely to follow. But that assumption is more difficult to make when you’ve got rising wages keeping prices unnaturally high. The ECB hasn’t yet been able to make that assumption. Its interest rates remain high.

But here’s what you should expect…

When the ECB finally decides to cut rates, they will do so substantially and they will do so quickly. It will be their way of reloading. Because we know, with the labor unions continually eroding profit margins and forcing prices higher, the ECB will need some fire power for their next inflation shoot-out.

If they cut back rates now, they’ll be able to hike rates and combat inflation when the time comes again. All you need to do is be prepared to act accordingly.

Source: The Inflation Story Nobody Is Telling You