It’s worth noting that Monday’s auction for 3-year debt was met with ravenous, near-record demand and that Tuesday’s 10-year sale met a bid-to-cover ratio of 2.8… historically high for the 10-year, but not even close to the 3.3 ratio for the shorter dated bonds the day before.

“The market is sending many errant signals right now,” notes Dan Amoss. “U.S. policymakers are trying to reinflate stocks, houses and wages, while also recapitalizing an undercapitalized banking system with overt and covert subsidies. All of these actions are extraordinarily costly — so costly that creditors are getting nervous.

For the rest of the article, read Ian Mathias at The Daily Reckoning.

The Dow rose 155 points on Friday. And today, stocks are rising in Asia. Oil is over $74. Gold rose $13 on Friday… to close at $954. And the dollar is killing us softly… sinking to $1.43 per euro on Friday.

Stocks and oil are at their highest levels so far this year. With such profits at hand people figure they don’t need the dollar. Investors run to the safety of the greenback when financial storms approach. But now… they think it will be clear sailing.

“Worlds bankers suggest rebound may be under way,” says a headline at the New York Times.

Is the world economy really recovering? Should you buy stocks now to take advantage of this new bull market?

You already know the answer, don’t you, dear reader.

After a fall comes a bounce. And along with the bounce come a lot of silly ideas. You see how it works? “Markets make opinions,” say the old timers on Wall Street. When stocks are going up investors find reasons why they are going up. Pretty soon, they’ve convinced themselves that they’ll go up forever.

But bounces do not last forever. They aren’t giant turtles… they’re moths. After a few months of flitting around bright lights, they dry up. When exactly this summer of winged love will end, we don’t know. September or October is our guess. But we have little doubt it will come to an end soon.

Ultimately, stock prices depend on earnings. People compare the rate of return they can get from stocks to what they can get from other investments. Rising earnings signal higher rates of return, so investors pay more.

During the great credit expansion of 1945-2007, businesses could anticipate, generally, rising earnings. People were buying more and more things on credit. In a national economy, businesses pay wages and then the employees use the wages to buy products. The wages are a ‘cost’ to the business… but they are also the source of business revenue. When sales come from credit, on the other hand, businesses have the revenue but no wage cost. Profits go up.

Now, the cycle has turned. Businesses still have the wage cost. But instead of using the money to buy things, the employee uses it to repay loans for purchases made last year or the year before. Now the business has the cost but not the revenue.

As they say in the economic textbooks: bummer.

The process of de-leveraging will be slow. Maybe 5 years. Maybe 15. Maybe 25. It will up and down… with high unemployment (businesses will cut their wage costs as sales fail to recover)… low prices (at least in real terms)… low profits… and slow growth, or none at all.

Is that bad? No, not at all. It’s good. Economies need to adjust to the new realities of the post-credit bubble world. It will take time. And with the world’s financial authorities fighting it every step of the way… it could take a LONG time. As we’ve explained in these Daily Reckonings, government is a profoundly conservative, parasite-protecting enterprise. It cannot draw forth the future – it has no idea what the future will be. Instead, all it can do is to try to recover the past. That’s the idea of the ‘recovery’… to try to coddle, protect and pay-off yesterday’s success stories. From Wall Street to welfare… governments attempt to prevent correction.

And more thoughts:

*** The Obama administration announced that it expects $9 trillion in deficits over the next 10 years. One of the great mysteries of our time is: where will the money come from? As we pointed out last week, even if every dollar of US savings is applied to the task, the feds will still be short. And if they make up the difference with funny money – from their quantitative easing scam – the Chinese vigilantes are likely to get cheesed off and dump their US Treasury bonds.

The evidence shows that the Chinese…and other Asians…are already trying to lighten up on their US debt holdings. This from the New York Times:

“Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.

Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month’s data. In May, China increased its holdings by $38 billion, according to the Treasury figures.

“Nonetheless, the decline highlighted a fact… Asia’s appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits… In the first half of 2009, China and Hong Kong acquired only 9 percent of the more than $800 billion worth of Treasuries that were sold.

“ Japan, which was replaced by China as the largest foreign holder of Treasuries last year, has been a larger buyer this year, taking up 11 percent of the new supply of Treasuries.

“Ownership of US Treasuries by China, Hong Kong, Japan, South Korea, Singapore, Taiwan and Thailand — since 1994 — rose to 25 percent, from less than 8 percent. Since then, as budget deficits in the United States grew, the share has fluctuated within a narrow range. In June, it was 24.7 percent.”

If Asians don’t finance US debts, who will? We don’t know… But the fewer bonds Asians buy… the more they are bought with funny money by the Fed. And the more the Fed buys with funny money the fewer Asians want to buy with real money.

How will this end? Badly…we keep saying. There is no way out. Either the feds cease spending more than they can raise honestly, by taxation and reasonable borrowing. Or, the system runs into chronic, mega deficits…like the chronic deficits in the private sector during the bubble years. Then, it blows up.

That is why we caution readers against the dollar and against Treasuries. Most likely, they will both go up this autumn…as investors flee to safety from the next market downturn. But the chances of them blowing up completely are too great. That’s why we stick with gold – even though we would not at all be surprised by a period of weakness in the gold market.

*** On Friday night, we went to a ‘dinner in white’ at a nearby chateau. It was a jolly affair, at an ancient chateau entirely surrounded by a moat.

We set up our table, alongside the others. We gathered for drinks. We saw old friends. And then we prepared for dinner.

Why “white?” The dinner marks the occasion of the Assumption of the Virgin. It’s held each year in this rural area of France. Everyone brings a full dinner service – table, chairs, candles, etc. etc. Then, after setting up outside, under the stars… there’s a twist. Couples switch around so that your editor ends up having dinner with a woman to whom he is not married.

Having dinner with someone else’s wife can be a delight. At least, you have nothing to argue about. But how much of a delight it is depends entirely – or perhaps mostly – on chance.

In our case, we were trebly lucky. In front of us was a charming woman who turned out to be a relative of many people we already knew. So we kept up a lively conversation about cousins, uncles, aunts… family tragedies… and upcoming marriages. On our right, was a cute woman with a bright smile and a friendly manner. On our left, was another charming woman with a shrewd, fast wit.

Time passed quickly. We crossed swords with the woman on our left – over education policies. We chatted with the woman in front of us – about family, the weather, local trends, food and whatever. We flirted with the woman on our right:

“Do you come to these dinners often,” we asked.

“About as often as you do,” came the reply, “once a year.”

“Well, the dinners suit you. You look very nice in white.”

“Thanks… but I really don’t have any choice. It’s a ‘dinner in white,’ after all. If I had a choice, I’d wear black.”

“Why… because you have a black, cruel heart? Or is it because you are in a sad mood? I hope not. And if so, perhaps I can cheer you up by telling you joke. How many Belgians does it take to change a lightbulb?”

“I’ve heard that one.”

“Then why does the guy from Belgium go to sleep with one full glass of water next to his bed and one empty glass?”

“I don’t know… why?”

“Because he never knows if he’ll be thirsty or not when he wakes up in the night.”

“Oh…”

Source: The Future Will Come

Good day…The dollar continued its assault on the world’s currencies yesterday as the dollar index moved above the 74 handle. I pulled a chart off the Bloomberg on my way out the door last night, and it showed the only major currency which was up vs. the US$ yesterday was the Swedish krona, which managed a .07% increase. This dollar rally has legs, but I still question the fundamentals behind the dollars surge. Today may be the day we see the dollar finally make a turn, as the ECB will be announcing their rate decision.

It is not that I expect Trichet to raise rates, but I do expect him to sound hawkish and refocus the markets attention on Eurozone inflation and away from worries about growth. Two reports out of Germany this morning will bolster Trichet’s hawkish stance. German exports rose more than economists expected in June, defying a stronger euro and pushing the trade surplus to a record. Exports increased 4.2% from may, the most since September 2006. German industrial production also increased for the first time in four months with output rising 1.7% from a year earlier. The IMF last month rose its forecast for German economic growth this year and said the global slowdown linked to the US financial crisis was less severe than it expected.

The entire global economy has been dealing with commodity price inflation, but so far this raw material price spiral hasn’t spilled over to wage pressures. While the severe slowdown in the US economy won’t allow increases in wages, the European economy isn’t in as bad of shape. Lufthansa, Germany’s largest airline, just announced a 5.1 percent raise to settle a strike. And Lufthansa employees aren’t alone in securing inflationary pay deals in Germany. Negotiated wages jumped 3.5% in the year through April, the biggest gain in 12 years. This wage spiral will keep the ECB focused on inflation, with another interest rate increase possible. ECB council member Klaus Liebscher signaled there may be need for still higher borrowing costs in Europe, saying in a July 24 interview that “we haven’t exhausted our room for maneuver”.

The euro rallied against the dollar in early European trading on speculation European policy makers will continue to hold their tightening bias. One of the reasons for the spike in the value of the US$ has been a shift in interest rate expectations. During the past month, several currency traders have begun to speculate that the next move by the ECB would be a drop in interest rates, while they gambled that the next move by FOMC would be up. Recent data would suggest these speculations could be completely wrong. The economic downturn looks like it will continue in the US, keeping the Fed from lowering rates, while the ECB is dealing with a stronger than expected European economy, and spiraling wage pressures. A change in these interest rate expectations could put the dollar back on its long term trend down, and send the Euro back to $1.60 or above.

The Bank of England kept the main interest rate unchanged for a fourth month as they find themselves in the exact same position as our Federal Reserve. Inflation has been accelerating, and the economy is teetering on the brink of a recession. UK housing prices dropped the most in a quarter-century and UK services, manufacturing, and construction all shrank in July. So the economy is dramatically slowing while inflation is predicted to more than double the 2% target. BOE policy makers split three ways on which direction interest rates should move, so their only choice was to just leave them where they are. England’s economic situation has left the BOE as impotent as the FOMC!

As I mentioned above, the UK reported that house prices fell at a rate of 8.8% in July. This morning we will get a better picture of the current status of the US housing market. A report from the National Association of Realtors will probably show its index of home sales fell for another month. The inventory of unsold homes in the US stands at the highest level ever recorded. And according to economists, the inventory of existing homes and condos must fall by almost 50 percent for prices to stabilize. Theres is an 11.1 month supply of existing unsold homes at the current sales pace, up from 4.6 months in September 2005. Almost one of every 10 US mortgages was in trouble during the first quarter according to the Mortgage Bankers Association.

Those that want you to believe the ‘worst is over’ in the US economic downturn only need to look at the pending home sales numbers, which is usually seen as a leading indicator. The index of pending home resales is expected to have fallen 1% after a decline of 4.7% in May. As we have been reporting for some time now, the falling housing market has far reaching effects on the US economy. While the folks at CNBC have been telling everyone that the worst is over after Paulson and Bernanke came to the rescue of Fannie and Freddie, some very smart people (whom I agree with) are warning that losses will continue to mount.

Nouriel Roubini, the New York University professor who predicted more than two years ago that the US would fall into a recession because of the bursting of the housing bubble and rising energy prices is one who disagrees with CNBC. Ty Keough pointed out an interview with Roubini which appears in this week’s Barron’s. I would encourage any of you who are starting to ‘drink the Kool-aid’ being pushed by Paulson and Bernanke to read it. In the interview, Roubini predicts that we are in the second inning of a severe, protracted recession, which started in the first quarter of this year and is going to last at least 18 months, through the middle of next year. He goes on to say we can expect a total of $2 Trillion of debt related losses in our financial institutions. Roubini states that banks have only started to feel the effects of the housing downturn, and that consumer-credit losses and home-equity loan write offs will substantially add to their pain.

He ends the interview with this: “Leaving aside the fact that we are going to have a pretty nasty recession and international crisis, the global economy is going to grow at a sustained rate once this downturn is over. There are significant financial and economic problems in the US and that’s why I’m bearish about the US. But the emergence of China and India and other powers is going to shift global economics and politics radically, and the world is going to be more balanced in the future, rather than relying on one engine, which has been the US. ..I’m quite bullish about the state of the global economy..”

I agree with Roubini’s take on things, and the best way to protect your portfolio? International diversification. Keep a portion of your assets outside of the US$ in currencies and precious metals. Investors should view this dollar spike as an excellent opportunity to purchase currencies and metals at cheaper prices, dollar cost averaging to get your overall costs down.

Japan’s government said the economy is “deteriorating,” acknowledging for the first time that the country’s longest postwar expansion has probably ended. “There is a high possibility the economy has entered a recession,” the head of business statistics at the Cabinet office said in Tokyo today. The Japanese yen continues to come under pressure due to the weakening economy and the recent move back into carry trades. In these carry trades, investors borrow currencies at low interest rates, sell them and invest the proceeds into higher yielding investments, earning the ‘carry’. With market volatility easing over the past month, many investors have moved back into these carry trades, pushing the value of the funding currencies of Japan and Switzerland down. As in the past, these carry trades can be reversed as quickly as they are put on.

Just in, the ECB left rates unchanged. Now we just have to wait Trichet’s press conference, which will occur in about 45 minutes. Better get to the currency roundup:

Currencies today 8/7/08… A$ .9106, kiwi .7178, C$.9546, euro 1.5468, sterling 1.9517, Swiss .9474, ISK 79.83, rand 7.4390, krone 5.1734, SEK 6.0846, forint 151.84, zloty 2.0966, koruna 15.54, yen 109.45, baht 33.58, sing 1.3837, HKD 7.8054, INR 42.06, China 6.8643, pesos 9.9398, BRL 1.5775, dollar index 74.08, Oil $120.17, Silver $16.60, and Gold… $882.40

That’s it for today… Chuck traveled out to San Francisco to speak at the money show. This is the first time in several years that I won’t be there, but things are just too busy on the desk as of late. I got to see Chuck at the Cardinal game the other night, and he was excited about getting back out to San Fran and addressing the crowds. I guess Brett Favre is headed to New York. I used to really like him, but this latest move dropped him a few notches in my book. Albert Pujols hit a Grand Slam last night to propel the Cards to another win. Maybe we will have post-season baseball in St. Louis! Hope everyone has a Tub-Thumping Thursday!!

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837
www.everbank.com

Source: ECB to Change Dollar’s Direction?…