A Currency Crisis, Up Close

Dave Gonigam – May 17, 2012

  • A currency crisis, coming soon to an economy near you: Irish trading in punts again, while Argentines deal contraband dollars at schools and offices
  • Dollar drops, gold soars: Traders suddenly anticipate QE3, but one chart shows it’s not in the cards yet
  • Sign of the times: Japanese pension fund adds gold to compensate for zero interest rates
  • The Goldman Swirl… the coup de grace to the First Amendment’s “Yemen exception”… Addison on Facebook… and more!

   This is what a currency crisis looks like: When something that hasn’t been legal tender in a decade comes back into circulation.

“We wanted to bring back the Irish pound — the punt, as it’s known… to increase business,” says Tony Morgan, a shop owner in the town of Clones. “We thought it would be a quirky idea initially. But we got absolutely fantastic coverage with this, and we’re getting people into the town.”

Ireland adopted the euro in 2002… but evidently a whole lot of Irish still have the old bank notes lying around. “If somebody has 20 pounds,” says Mr. Morgan, “that’s 24 euro more than they thought they had — because they wouldn’t expect to spend that.”

“Customers who bring in old bills and coins,” the CBC reports, “don’t get change back in cash — instead, they’re given Clones Town Euro Vouchers that can be spent in participating businesses.”

So it’s a twist on local currencies like BerkShares or Ithaca HOURs. It’s definitely not a political statement, says Morgan. Rather, it’s a matter of necessity. “We have to look at new initiatives, no matter how mad they appear initially, like this.”

   “I’ve changed money at my children’s school,” says an economist in Argentina — also going through a currency crisis.

“You’ll find these kinds of deals at every school in (wealthy areas like) Palermo, Recoleta, Belgrano and Martinez, and a black market inside every office.”

President Cristina Fernandez de Kirchner wants the U.S. dollars that come from a growing trade surplus to stay in Argentina — the better to pay down the government’s staggering debt.

Ordinary Argentines want the dollars for themselves — rather than increasingly worthless pesos. Thus is the government imposing Byzantine rules and encouraging a black market in currency.

“Fernandez must curb capital flight,” says a Reuters story, “in a country still wary of government intervention after the currency devaluation and bank deposit freezes of its 2001-02 financial crisis.”

   “Not only did they default on the debt and devalue the currency,” Addison says of that sorry episode a decade ago, “they nationalized pension assets. They even closed the banks!”

And when they reopened, cash withdrawals were allowed only in pesos — even if the customer deposited dollars. Before the corralito, the peso was pegged 1:1 with the dollar. After, it was 4:1. In other words, 75% of Argentines’ purchasing power had been vaporized by government diktat.

“Similar things can happen here,” write Addison and Samantha Buker in The Little Book of the Shrinking Dollar. “That’s the catch. Capital controls can enslave your money and keep it within borders. The worse things get, the more troubled governments hate that you and your dough can escape.”

The U.S. government is surely no exception. The book suggests several defensive measures… as part of a total 47 ideas to preserve your purchasing power. You might want to get a copy for yourself — while all 47 remain legal.

   After a flat open, U.S. stocks are tumbling again today. As of this writing, the Dow is less than 30 points above 12,500.

“I’m on watch for a turn,” wrote Options Hotline’s Steve Sarnoff to his readers last night, “as conditions ripen for a potentially dramatic reversal. But until proven otherwise by price action, sellers have the advantage.”

   The catalyst for today’s stock drop — if there was one at all — came not from Greece, but instead was homegrown.

Manufacturing in eastern Pennsylvania and New Jersey looked markedly worse this month, judging by the Philly Fed survey.

The index turned in a negative number for the first time since September. Whoops… the “expert consensus” was looking for not only a positive number, but a higher one than the month before.

Rotten as the headline figure was, the internals were worse: Employee head counts and length of workweek turned negative. How’s that recovery working out for you?

   The reaction to the Philly Fed report in the currency market was… well… interesting.

The dollar index peaked at a multimonth high of 81.7 in overnight trading. The moment the Philly Fed report came out at 10:00 a.m. EDT, it dropped like a rock. Right now it’s 81.3.

Going by the cable channel chatter, you’d think this single data point all but guarantees QE3 is in the bag. After all, the minutes from the Fed’s April meeting released yesterday indicated an openness to “additional monetary policy accommodation.”

   That’s what the Fed says. This chart begs to differ.

This is the Federal Reserve’s “Five-Year Forward Break-Even Inflation Rate” Using a formula involving Treasury Inflation Protected Securities (TIPS), Fed wonks take a stab at where investors believe inflation will be five years from now.

“The first thing you should notice,” says our resident technician Jonas Elmerraji, “is the yellow horizontal line at 2.2% — if this were a price chart, we’d call it a support line.”

“Instead, it’s an important inflation target for the Fed: Every time that inflation rate has dropped below 2.2%, the Fed has plowed money into the market. It happened the first time with QE1 in 2008. Then again with QE2 in 2010. And most recently, it happened with Operation Twist late last year…”

“The next round of quantitative easing,” concludes Jonas, “isn’t going to have anything to do with jobs numbers, stock prices or manufacturing data. Directly, at least, it’ll have everything to do with inflation.”

   Regardless, precious metals traders took the same cue from the Philly Fed report that currency traders did.

Gold shot up more than $20 the moment the report came out. At last check, it’s up to $1,574. Silver, meanwhile, has recovered the $28 level, just barely.

   Gold demand worldwide fell 5% year over year during the first quarter, according to the World Gold Council.

Jewelry consumption fell 8%, a phenomenon driven largely by India’s decision to increase import taxes on gold.

Investment demand rose 13%. The driver here, not surprisingly in light of the import figures we harp on, is China.

“It is likely China will become the largest source of demand for gold in 2012,” eclipsing India, says the council’s managing director for investment Marcus Grubb.

   For the first time, a Japanese pension fund is buying gold, in what the Financial Times characterizes as “a sign of dwindling faith in paper currencies.”

Okayama Metal & Machinery will put about 1.5% of its pension assets into bullion ETFs.

“The move into a nonyielding asset,” reports the salmon-colored rag, “comes as funds in the world’s second-biggest pension market are under increasing pressure to meet promised payments, as domestic interest rates remain rooted near zero.”

Hmmm… sounds a lot like another country we know well…

   Meanwhile, someone at Goldman Sachs with too much time on his hands has come up with a “swirlogram” that attempts to depict the world economy’s booms and busts of the last 18 months.

It’s derived from Goldman’s “global leading indicator,” an index that aims to highlight trends ahead of economic reports released by individual governments.

One obvious take-away is that the global economy will head back into a mild expansion come this summer.

The other is that the swirl will continue to make tighter and tighter circles until it collapses in on itself right around the time the world ends anyway, on Dec. 21, 2012…

   “The U.S. might soon get a competitor ‘developed’ country to tax its citizens abroad,” a European reader writes after yesterday’s episode spotlighting the expatriation of Facebook co-founder Eduardo Saverin.

“France is on the verge of introducing it, and, in fact, had been contemplating doing it even under a right-wing government. Personally, I disapprove of the system, but at least the U.S. will feel a little less lonely…”

Meanwhile, in response to Addison’s remark that “the U.S. should have a tax system that makes it attractive for him to want to stay,” an Asian reader writes: “In other words, Singapore has a tax system that makes it attractive for him to want to come…along with Hong Kong and, even more so for retirees, Malaysia.”

The 5: As if to make the U.S. system even less hospitable, we see two U.S. senators have drawn up a bill that… well, see if you can figure it out from this description at Politico:

“It would require Saverin and others who renounce citizenship to pay taxes at a 30% rate on any U.S. investment. The penalty only will ‘prospectively impose a tax on an individual’s future investment gains,’ according to a summary of the bill — suggesting it may not touch amounts Saverin stands to make with the IPO and others who long ago dodged the tax bullet. However, Schumer said it would still affect Saverin and others who invest in the United States to maintain their net worth.”

This is what happens when congressional aides hastily write legislation based on a hot story, and reporters on deadline try to summarize it. We still have no idea what this bill would actually do… other than chase capital away from the “land of the free.”

   “Have you made sure,” another reader writes, “that yesterday’s 5 has been made available to the several organizations that purport themselves as proponents for preservation of the First Amendment?”

The 5: No… because we’re still marveling over something that escaped our notice about the Yemen executive order: U.S. government agencies are exempt.

Thus, as blogger Marcy Wheeler explains it, “While Obama doesn’t want you, or [the former dictator] Saleh’s leave-behinds or the AP to destabilize Yemen, he reserves the right for U.S. government employees, grantees or contractors to do so.”

   “I have to second the thanks to you from the subscriber who lives in Indiana regarding unlawful entry by the police,” a reader writes. “Please keep up your good work.”

   “Seriously?” writes a dissenter. “This guy in Indiana thinks he can get away with shooting a cop who ‘unlawfully’ enters his dwelling?”

“Good luck proving that one in court. If by some bizarre twist of circumstances his buddies haven’t already riddled you like Swiss cheese. It’s a police state now. Yes, plan to fight back, but don’t be so naive as to think you can ‘legally’ get away with it. If you shoot at a cop, you are going to jail or the morgue — count on it.”

   “I read with interest the comments by the Canadian reader about the ignorance of his students and those at Towson on matters of finance and economics.”

“After over 25 years in the accounting profession, I am semiretired and work as a private tutor. It would be easy to say nothing has changed between his class and Addison’s talk, but in my experience, that’s not true. It’s gotten worse.”

“When I try to teach my students about finance, economics or just generally what’s going on in the world, I have to start totally from scratch. Most of my students are middle school kids from the same sort of background. The ignorance is appalling. They don’t know where Brazil is, they think Mexico is a continent, they can’t understand ratios and percentages and the examples go on and on.”

“When I ask them questions like ‘How does electricity get to your house?’ or ‘Where does your food come from?’ I get one-word answers like ‘wires’ and ‘The grocery store.’ I really am concerned for their future.”

“I want to thank you for all the great information I get from you at Agora Financial. You are helping me turn my life around.”

The 5: You’re welcome!


Dave Gonigam
The 5 Min. Forecast

P.S. Addison has joined the Facebook generation. And no, not because of the IPO tomorrow (about which we’ll surely have a thing or two to say).

Among the photos he shares at his page: a coffee-stained manuscript of The Little Book of the Shrinking Dollar. It doesn’t get more real than that. You can friend him right now at this link.


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