Australian Dollar

One of the dirty little secrets of the stock market rally is that the rising corporate profits that powered it are largely phantom profits. Why are they phantom? Because they are artifacts of currency devaluation, not an increase in efficiency or production of goods and services. Though few domestic observers make mention of it, the large, global U.S.-based corporations are now dependent on non-U.S. sales for about 40% of their revenues (50% and up for many companies) and virtually all their profit growth. Overseas sales are made in the local currency: the euro, yen, renminbi, Australian dollar, Canadian dollar and so on, and the profits are stated in U.S. dollars on corporate profit and loss statements. In 2002, 1 euro of profit earned by a U.S. global corporation equaled $1 in profit when converted to U.S. dollars. That same 1 euro profit swelled to $1.60 in 2008 as the U.S. dollar depreciated against the euro. That $ .60 of profit was phantom, an artifact of the depreciating dollar; it did not result from a higher production of goods and services or greater efficiencies.

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When all else fails, pretend it's all good. Like what Australia did, following the just released announcement by the RBA that it is keeping the cash rate unchanged at 4.25% on expectations of a 25 bps rate cut. Which begs the question: is China re-exporting the lagging US inflation it imported over 2011? So it appears to Glenn Stevens, who just said that "Commodity prices declined for some months to be noticeably off their peaks, but over the past couple of months have risen somewhat and remain at quite high levels." Or maybe they are not pretending and inflation is still alive and very much real? It also means that Chinese inflation continues to be far higher than what is represented, but we probably will just take the PBoC's word for that. Or not, and wonder: did the RBA just catch the PBOC lying about its subdued inflation? And if that is the case, does anyone really wonder why that very elusive RRR-cut is coming with the same certainty as the Greek creditor deal? Either way, the AUDJPY spikes by 80 pips on the news, however briefly, and if the traditional linkage between the AUDJPY and the market is preserved, it should have a favorable impact on risk as it means at least one hotbed of inflation remains. On the other hand, it also means that Chinese easing is a long way off... and in a market defined solely by hopes for central bank intervention this is not good. And amusingly, just as we write this, Bloomberg release a note that the PBOC is draining funds: "China’s money market rates rose after PBOC resumed fund drain via a repo operation, showing it remained cautious toward policy easing." Translation: "Hopes for a near-term RRR cut could be dashed, Credit Agricole CIB strategist Frances Cheung writes in note to clients." Oops. Furthermore, the PBOC did 26 billion yuan in repos, meaning it is set to conduct a net liquidity withdrawal for this week according to Credit Agricole. Withrawing liquidity when the market expects RRR cuts? Fughetaboutit. (and reread the Grice piece on why only idiots define inflation by the CPI or the PCE).

All you need to read.

All you need to read.

One of the more useful Wall Street fictions is the naive notion that big players and small-fry equity owners alike love low-volatility "melt-up" markets that slowly creep higher on low volume. The less attractive reality is that big trading desks find low-volatility "melt-up" markets useful for one thing: to sucker retail buyers and less-adept fund managers into an increasingly vulnerable market. Beyond that utility, low-volatility "melt-up" markets are of little value to big trading desks for the simple reason that there is no way to outperform in markets that lack volatility. The retail crowd may love a market that slowly gains 4% for the year, barely budging for months, but such a market is anathema to big traders. It's always useful to ask cui bono--to whose benefit? In this case, highly volatile markets don't benefit clueless retail equities owners, as they are constantly whipsawed out of "sure-thing" positions. From the big trading desk point of view, this whipsawing provides essential liquidity, as retail traders and inept fund managers trying to follow the wild swings up and down provide buyers. I have a funny feeling the "smart money" has built up a nice short position here and as a result the market is about to "unexpectedly" decline sharply. The ideal scenario for big trading desks here is a sudden decline that panics complacent retail traders and managers into selling (or leaving their stops in to get hit).

All you need to read.

All you need to read.

Australia is the sixth-largest country (2.9m square miles) on earth, just a tad smaller than the contiguous United States (3.1m). They are a little short on people (22.8m), which comes handy, since they dig up their entire country and sell the dirt to China. Australia has a remarkably low government dept-to-GDP ratio (29% ), low unemployment (5.2%), a moderate budget deficit (3.4% of GDP) and moderate inflation. However, Australia has been running current account deficits of up to 6% of GDP for more than 50 years. The “mates”, until recently, didn’t like to save, hence most investment has to be financed by borrowing from foreigners. I was curious as to how much of the success was due to exporting dirt to China. From the Australian Bureau of Statistics you get the following data about their top-10 export markets (accounting for 82% of all exports)...

Hedge funds poured into the currency down under, making it one of the world’s best performing assets this month. The bottom line is that interest rates there are high and rising, while ours are low and stagnant. A procession of central banks have been pulling the ripcord on the troubled euro and landing into currencies with vastly better fundamentals. A proposed 40% mining tax triggers a stunning change in government. Singing “Waltzing Matilda” in the shower. (FXA), (EWA).

The lucky country has become accident prone. Shooting itself in the foot with a 40% special tax on the profits of mining companies. Start scaling back into the Ausie dollar and the Ausie/euro cross. Australian stocks should be at the top of your list too. (FXA), (EWA).