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“They must often change who would be constant in happiness or wisdom.”

-Confucius

 

Changing your economic policies as the facts do is not easy; particularly if politics stand in your way. Unlike Western countries, China has positioned itself to make monetary and fiscal policy decisions when it wants to make them, not as the political wind of Fiat Fools blows.

Club Myopia  in Washington will tell you that China’s decision to allow the Chinese Yuan to appreciate this morning was driven by American political pressure. That’s obviously ridiculous. Ever since they laughed at Timmy Geithner last year, the Chinese have done nothing but smile and nod.

Not unlike their decisions to appreciate the Yuan between 2005 and 2008, the main drivers of China’s move this weekend were domestic growth and inflation. We’ve shown this chart many times and we’ll put it up on Hedgeye.com again today, but when you overlay the sequential rate of change in China’s consumer price inflation (CPI) with the Chinese Yuan, the catalyst for currency revaluation becomes crystal clear.

Ronald Reagan and Paul Volcker figured this out a long time ago. Now the Chinese are trying to apply past American Wisdoms. Whether it works or not remains to be seen, but the domestic benefits associated with having a strong national currency are huge.

Both inflation and politics are local. The best way to ensure political safety and benign inflation at home (at the same time) is to maintain a strong currency. This will sound very foreign to the Japanese, European, and American Fiat Fools. They believe in debasing the Yen, Euro, and Dollar anytime there is a whiff of stock market weakness. It’s sad.

Stock and commodity markets around the world are moving higher on this Chinese news this morning because a stronger currency for the world’s strongest sovereign balance sheet means China has more purchasing power. Gold is hitting all-time highs at the same time that prices from sugar to oil are charging convincingly above their immediate term TRADE lines of support.

After he is done attempting to smirk, Timmy Geithner should realize that the corollary to a strong Chinese Yuan is a weaker US Dollar. This is another reason why assets priced in US Dollars are charging higher this morning. Dollar down equals assets priced in dollars up, for a trade.

Unfortunately, this also means that the sovereign risk implied on America’s balance sheet goes up this morning. The US Dollar is hitting a 4-week low, and is now decidedly broken from an immediate term TRADE perspective.

We are long a 12% position in Chinese Yuan (CYB) in the Hedgeye Asset Allocation Model. We’re also short the US Dollar (UUP) so from a currency exposure perspective, today is going to be a good day. Unfortunately, irrespective of what US stock market futures are doing this morning, today is not a good day for modern day Rome’s Financial Empire.

We showed this chart in Friday’s Early Look “Guarding The Guards”, and it’s worth reminding you of its long term consequences. Since the US was endowed with the global fiduciary responsibility of managing the world’s reserve currency in 1971, with the exception of the Volcker years, it has done nothing but erode the credibility of that global currency.

In that chart we outlined the long term TAIL line of resistance for the US Dollar Index at $88.89. China’s decision this morning is only going to reinforce that long term level of resistance as the US Dollar continues to break down below what was immediate term support.

When support becomes resistance in the immediate term (3 weeks or less in our model), we call that a change on the margin worth managing risk around. On this score, risk works both ways (when resistance becomes support it’s bullish), and that’s why we covered our short position in the SP500 (SPY) earlier last week.

Currently, the immediate term TRADE line of resistance for the US Dollar is $86.69. Last week alone, after the Fiat Fools at the Fed ballooned the balance sheet to $2.35 TRILLION Dollars, the US Dollar Index lost -2.1% of its value on a week-over-week basis. Since its intermediate term closing highs early this month, the US Dollar Index is down -3.3%.

China is America’s creditor. I’m not sure whether or not the professional politicians in Washington get that or not yet. But, as we head into the G-20 meeting next week in Toronto, the Chinese are definitely going to remind the world who is wearing the pants in this financial relationship. China holds $900.2B in US Treasuries and has plenty a reason to ask Timmy what he’s thinking about Chinese Wisdoms now.

My immediate term support and resistance lines for the SP500 are now 1097 (immediate term TRADE line) and 1144 (intermediate term TREND line), respectively. On Friday, we took our asset allocation to US Equities up from 3% to 6% - we bought the ETF for Utilities (XLU).

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

Chinese Wisdom - CHINA