http://www.dailyreckoning.com/RSS/062107.html Paulson Drinks the Kool-Aid
-------------------------------------------------------------------------------- "I find it a little funny that while U.S. Treasury Secretary Paulson states that the mortgage mess is 'no problem', others who are obviously more removed from the situation see it as a ticking time bomb." -------------------------------------------------------------------------------- by Chris Gaffney In This Issue. a.. Treas. Sec. Paulson drinks the kool aid b.. An intelligent Central Banker speaks c.. Mr. Yen calls yen's price absurd d.. Slow and steady in China --- Advertisement --- Customers at EverBank® are celebrating the launch of the enhanced EverBank Online Financial Center, their new Online Banking site. EverBank has integrated user-friendly technologies designed to deliver a better banking experience, including: - An improved look and feel - Enhanced Bill Pay - New electronic bill presentment and stronger security. If you're not already an EverBank customer, now is a great time to become one. Visit everbank.com today. EverBank --------------------- And now.today's Pfennig! Paulson Drinks the Kool-Aid Good day. The currency markets were steady through most of the day yesterday as the mortgage mess kept buyers of the U.S. dollar away, while expectations of stronger U.S. economic indicators kept investors from selling. Overnight the dollar has gained ground versus the euro (EUR) and yen (JPY) as we near the release of a report on U.S. manufacturing, which may show that the economy is picking up from the slowest pace of growth in four years. After the weekly jobs numbers, which are expected to be little changed from last week's data, the leading indicators gauge from May will be released followed by the Philadelphia Fed's manufacturing numbers. The Conference board's leading indicators are expected to rise 0.2% after last month's 0.5% decline. The index points to the direction of the economy over the next three to six months, so a jump back into positive territory may ease some of the concern caused by the negative data on the housing market which we have seen over the past few days. U.S. Treasury secretary Paulson is talking like he has already seen the numbers, saying yesterday that the economy is "strong" and the collapse of the U.S. subprime mortgage market "doesn't pose a significant risk". But not everyone at the Fed agrees with Mr. Paulson, as Dallas Fed head Fisher stated in a speech yesterday that the housing correction "will take longer to run its course than most economic analysts have felt it would take". As I have pointed out numerous times, the information I have been reading shows the housing market is no where near the bottom, and the effects of this housing slowdown have only just begun to trickle down into the other economic data. While one week's labor and manufacturing data may show a slight turn around, the real trouble is still on the horizon. This morning's dollar gains will not last long as data released in Europe continues to confirm that rates are going to have to increase to offset inflationary pressures. European manufacturing and service industries - making up two-thirds of the economy - grew at an unexpectedly rapid pace in June according to the Royal Bank of Scotland Group's combined index. The index rose from 56.8 to 57.7 while most economists expected to see it drop. A reading above 50 indicates expansion. The euro area economy expanded 0.6% in the first quarter, three times the rate of growth in the United States. Unemployment in Europe has dropped to a record low of 7.1% in April and business and consumer confidence reached a six-year high in May. Europe is obviously picking up steam while the U.S. economy is continuing to waiver. ECB council member and Belgium central bank head Guy Quaden summed up the current state of the world's economy quite nicely in a report published this morning: "Macroeconomic conditions have remained robust over the last 12 months. A gradual rebalancing of growth from the U.S. to Europe and Japan has enabled the global pace of economic expansion to be maintained, while curtailing the balance of payments disequilibria between the major regions of the world. The high cost of energy and increased use of production capacity has put upward pressure on prices, leading most central banks to raise their interest rates." Quaden goes on to warn about the high degree of leverage and the possible implications it has for the global economy: "Despite this favorable environment, signs of nervousness and periods of turbulence have recently been observed in the financial system. In a context where the search for yield has not only led to a very tight pricing of risks but has also induced some market participants to strongly leverage their investments, it would not be surprising for even small changes in market conditions to result in a rapid unwinding of positions and sharp price adjustments. Some segments of the market, in particular the U.S. subprime mortgage market, are already facing problems, while others, such as the market for leveraged private equity buyouts, could become vulnerable." After reading this report, I just had to include it in today's Pfennig as it eloquently reflects my thoughts on the current state of the global economy. I find it a little funny that while U.S. Treasury Secretary Paulson states that the mortgage mess is "no problem", others who are obviously more removed from the situation see it as a ticking time bomb. I think Paulson has been "drinking the Kool-Aid" of the current administration and is ignoring what is likely to become a major economic event over the next few years. Now back to the currency markets. Look at this dip below $1.34 by the euro as a buying opportunity as a report tomorrow is expected to show that German business optimism is buoyant. The Ifo institute's sentiment index probably reached 108.4 after May's reading of 108.6. These are the highest readings since records began in 1991. If the Ifo data come in where expected, the euro will likely move back up over 1.34 as the focus will return on the ECB and the likelihood of at least two more interest rate increases this year. The yen continues to be sold as Japanese households move earnings overseas in search of higher yields. Apparently it is bonus time in Japan, and with interest rates lower than anywhere else in the industrialized world, Japanese workers continue to sell the yen and move the proceeds into higher yielding markets. "Mr. Yen", Eisuka Sakakibara, whom we have quoted several times in the past, continues to warn of the risks associated with these flows out of the yen. Sakakibara, who got his nickname when he was the top currency official to Japan's Ministry of Finance, said the Bank of Japan needs to increase interest rates soon because the yen's slide has fueled a "dangerous" bubble in carry trades. "The cheapness of the yen has reached absurd levels and the only cause for that is low interest rates," Sakakibara said in an interview yesterday. More of the same out of China overnight, as another Chinese central banker reaffirmed the government's policy of keeping the renminbi (CNY) stable, a day after Secretary Paulson said he'll seek "more creative" ways to press for increased flexibility. The world must be "patient" over the pace of the nation's economic policy changes according to Wu Xiaoling who is deputy governor of the People's Bank of China. But the U.S. Congress is quickly running out of patience and will continue to put pressure on the administration to do something about it. "I share your frustration on the pace of change in China," Paulson told U.S. lawmakers in testimony yesterday. "We clearly found that the currency is undervalued, that it doesn't reflect economic reality." What I find amazing is that while Congress and Paulson continue to focus on China and the obviously undervalued renminbi, neither wants to try and address the mortgage mess right here at home. I think it is obvious the Chinese are going to move at their own pace, despite any attempts to force them otherwise. The Chinese renminbi will increase in value as increases in interest rates and economic growth will allow the Chinese government to accelerate the currency's appreciation. I don't look for an overnight revaluation, but gradually faster appreciation. Currencies today: A$ .8459, kiwi .7620, C$ .9373, euro 1.3379, sterling 1.9898, Swiss .8051, ISK 62.39, rand 7.1733, krone 6.003, SEK 6.9198, forint 185.83, zloty 2.8320, koruna 21.4172, yen 123.66, sing 1.5383, HKD 7.8120, INR 40.73, China 7.8205, pesos 10.8485, dollar index 82.51, Silver $13.16, and Gold. $652.55 That's it for today. Spent a wonderful evening with my wife as we attended an outdoor concert by John Mayer. The weather was absolutely amazing which helped to make it a great night. I plan on stopping by to see Chuck tonight, so I'll be able to give you a first hand account of his recovery. Hope everyone has a terrific Thursday!! P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed. Editor's Note: Chris Gaffney is Vice President of EverBank World Markets and the alternate author of the popular "Daily Pfennig" newsletter. This valuable newsletter is delivered via email to tens of thousands of market watchers globally, and helps traders stay on top of the economic, currency, and market happenings. Mr. Gaffney has been involved in investment services since 1987 and is director of sales for structured products at EverBank World Markets. He is a Chartered Financial Analyst and also holds degrees in accounting and finance from Washington University in St. Louis.