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“It does not matter how slowly you go so long as you do not stop.”
-Confucius

Finally! Last night, someone had Steve Forbes give Larry Kudlow a tutorial on our two factor global macro model: Chinese Demand and The US Dollar. At the end of Forbes walking through our Burning Buck thesis, Kudlow actually cited Confucius – well done Larry, you’ve evolved!
 
What this means is that consensus on the US Dollar is finally registering as bearish enough. What are this morning’s confirmations of our 6-month old Burning Buck thesis?
 
1.      Wall Street Journal – Dollar Down is a front page story this morning

2.      UBS - the world’s 2nd largest currency trader is “cutting their US Dollar” forecasts this morning (thanks for the Early Look!)

3.      China, Russia, and even the United Nations are calling for a redo of Bretton Woods!

 
As Forbes pounded home last night, this isn’t rocket science (maybe that’s why the hockey head got this right!). It’s been politically unacceptable for Washington to confront while in the moment. Now, as the STAGFLATION 101 tutorial takes its time morph into Wall Street’s storytelling, President Obama is going to have to deal with this political football. He is more of a basketball guy. Unfortunately, on his currency bench, all he really has to defend the Dollar is a Squirrel Hunter.
 
Understanding that his glaring partisan political views perpetuate his being allowed to understand Forbes’ Burning Buck revelations, Kudlow and many other raging Republicans are definitely going to take the Democrats to task on this – as they should. Bush was held liable for a cycle high August of 2008 US CPI (Consumer Price Index) reading of +5.3%. Remember $150/barrel oil? Goldman’s analyst would rather you wouldn’t – so would the politically polarized US Federal Reserve. Politicians are perpetuating price volatility, not “traders”…
 
At the end of the day, this isn’t about political parties. This is about the most politicized monetary policy that this country has ever seen. Both Bush and Obama signed off on a Burning Buck. This isn’t about being a Republican or a Democrat. This is all about having The Creditor’s pay the Debtors bills.
 
Again, Forbes was much more eloquent than my arthritic hockey knuckles can be in the morning in explaining that America’s Creditor is CHINA. So, I’d like to thank him for explaining that. The Creditor is no longer interested in sponsoring Lehman leverage ratios of 40:1, or the bonuses embedded therein. Nor are they interested in seeing the Fed’s balance sheet ramp for the 4th consecutive week to a new high of $2.09T US Dollars.
 
Back to stagflation – let me be clear that this one isn’t global this time. It’s very much a pending US problem. It’s born out of Burning the Buck. As the US Government torches the US currency, they’ll import inflation in Q4. As inflation accelerates sequentially and growth remains stagnant, that’s called stagflation.
 
I know, I know – some of the Big G (government) Keynesians aren’t going to like this. Don’t worry, they got run-over being blind to it in the 1970’s as well. However, be sure that The Creditor has done the required reading on global economic history. That’s why the Chinese are buying gold and selling US Dollars. They aren’t paid by Hank Paulson and Co’s Wall Street of Gordon Gekko past to be willfully blind.
 
The Creditor’s stock market closed up for the 6th consecutive session last night, taking the Shanghai Composite Index to 2,946. Yes, Chinese shares have corrected -15% from their YTD high, but don’t forget that they are still +62% for 2009 to-date. The metaphor of American style leverage, the Dow Jones Industrial Average, is only up +8.2%, lagging almost every major stock market index in the world.
 
The Creditor’s New Reality trading partners continue to prosper alongside strengthening domestic currencies. Germany, Australia, and Hong Kong are all within 1% of their YTD stock market highs. At the same time, all of these countries do not sponsor the USA “Great Depression” emergency rate of ZERO percent for their respective countrymen’s savings accounts, nor do they sign off on Burning their local Bucks.
 
Germany reported 0% Consumer Price inflation for the month of August this morning. The way that this is going to work from here is that Germany’s white hot Euro ($1.45) is going to import consumer price deflation for their domestic savers. Again, stagflation is going to be a US centric problem – not the world’s problem. That’s why Gold can rage higher at the same time that US Treasuries hold a bid.
 
US Treasuries aren’t going down because the bond market doesn’t smell a sustained level of US growth going up. Gold is going up because the world’s reserve currency is burning. The combination of the two doesn’t enthuse The Creditor. The Creditor will be looking elsewhere to invest their savings as a result. When it comes to selling down their US exposures, “it does not matter how slowly” they go, so long as they don’t stop.

If the US Dollar stops going down today, I expect stocks and commodities that are priced in those Dollars to stop going up. Will the SP500 make a lower-high? We will have to see about that. My intermediate term Range Rover target to the upside for the SP500 remains 1041. I have my first level of support at 1016. Next stop after that is 1008.
 
Best of luck out there today,
KM


LONG ETFS

VXX – iPath VIX We bought volatility on its lows on 9/3 ahead of last Friday’s employment report.

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

 
SHORT ETFS
 
DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

LQD – iShares Corporate Bonds Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.