Currency War, Final Impact

Week ended September 29, 2023, interesting news items to look at this week were:

1. Currency War, Final Impact: I shared with my friends sometimes ago, it would be difficult to understand short term financial market volatility without an understanding of derivatives and leveraged trading. Case in point is the past 11 weeks strength in the USD. From beginning of 2022 to now, Eur (-6.49%), GBP(-9.13%) and JPY(-23.1%) have all depreciated against the USD which gave rise to a 10.42% uplift in the USD Index (DXY). (Fig. 1).

Without an analysis of actual data involved, off the cuffs remarks from professional investors and media commentators, ascribed the dollar strength to a flight of capital from Europe and Asia to US, high US interest rates and quantitative tightening by the Federal Reserve. It is the purpose of the following paragraph to debunk some of the myths and put different pieces of the puzzles together to identify a macro picture of money flows. In the process we will attampt to plot a pathway of where we have been and where the USD may be going.    

(i) No Capital Flight to US and De-dollarization is mainstream: Figures available on Bonds and Stock holdings cross the US border for the year 2022 and up to July 2023 showed there was a net capital outflow from the US of $643.3 billion comprising Foreigner sold down in US of $1.6 trillion and US Investors sold down overseas of $1 trillion as follows:

 

 

Reduction by US	$’ Million	Reduction by Foreign
Investors From	Country/Region	Investors Out from US
-482,283	Europe	-788,227
41,944	Latin America	51,824
-155,237	Caribbeans	-96,126
-241,917	Asia	-476,900
-117,593	All Other Countries	-288,988
-955,086	All Countries	-1,598,417

The funds arising from foreign liquidation of Securities were not retained in the US banking sector either as evidenced by a decline in deposits of US Depository Institutions within the same period. (Fig. 2)

(ii) It is not USD appreciation but Other Currencies Depreciation: Using the same FX graph of Fig. 1 as a basis, when we add in changes in Saudi’s Riyal (“SAR”) and price of Oil (Brent), the picture becomes clearer (Fig. 3).

All currencies as compared with the price of oil showed a devaluation. If we look beyond during the period under review, there were wild gyrations due to short term supply shocks, speculation of the Collective West’s oil price cap and the release of US Strategic Petroleum Reserves, we notice there is a shift in sentiment as the World looks at the status of a Reserve Currency. Notice particularly, since the July Russia and Saudi oil production cuts, the price of oil has climbed 21% and with it the Eur, GBP and JPY decline of respectively 2.82%, 4.08% and 2.63%. (Fig. 4).

The DXY climbed 3% as a result but still significantly lag behind energy price increases. In the past a rise in the strength of USD would limit a price increase in oil but that was in the past. Commodities exporting countries no longer are willing to exchange their resources for a reserve currencies that is devaluing on a perennial basis and further impaired by unilateral sanctions and expropriations. Natural resource exporting countries rather leave their resources in the ground for wealth preservation and sell just enough resources for their cash exchange needs.

(iii) Exorbitant Privilege: Former French President Valery Giscard d'Estaing called the US dollar and its position as the world's reserve currency “America's privilège exorbitant”.As at July 31. 2023 this Exorbitant Privilege means, on portfolio investment alone, an investment of US$26 trillion in the US by countries all over the world (Fig. 5).

Europe alone holds 45% and Asia holds another 31%. On top of portfolio investments, foreign investments in bank deposits, commercial and residential real estates and direct commercial and industrial investments would add tens of trillions in the US economy. Rather than acting as a Trustee with a duty of care, the Anglo Americans has the audacity to say“The dollar is our currency, but it's your problem,” and now the chicken is coming home to roost. In the preceding paragraph, we mentioned the world has come to a realization that the USD can no longer be regarded as a store for value, the next stage of course is to reduce trade surpluses in USD and reposition into other assets which maintain its value. The recent BRICS+ Summit in Johannesburg, G77 Meeting at Havana are all official channels to progress on this theme. Whilst financial commentators in the US boast USD as a Reserve Currency is a TINA phenomenon, perhaps the more relevant question to ask is not “what will replace the USD” but rather “what makes any country wants USD”. We have now come to the moment of final impact as cracks in the US Treasury market becomes noticeable to ordinary man in the street . For the past 6 months, the standard bearer of financial value, the risk free Tier 1 Asset of USGG10YR has fallen by 15% on an annualized basis. (Fig. 6).

Not only had the premium of physical gold at the Shanghai Gold Exchange refuse to be arbitraged to the paper gold price at London LBMA and NY Commex (Fig. 7).

This premium above the artificial gold price is now manifested even with Big Box retailer COSCO. (Fig. 8).

2. Sitrep Ukraine War:

(i) Rift in Relationship - Poland & Ukraine (Fig. 9). Whilst the Anglo Americans used Ukraine as just a pawn in a game, Poland and Ukraine shared the same hatred for Russia. However politicians won’t last long if they continue to back losers and Duda, President of Poland, is no different.

(ii) NATO Weapons & Tactics failed at Counter Offensive: (Fig.10) - Pentagon demanded all new recruits to be specially trained by NATO on a “successful formula” based on a playbook of a “Combined Arms Warfare Plan” in the Iraqi war. Sadly, Pentagon’s prior experience after WWII were all wars with a much smaller and weaker enemy and this proved a total disaster against a peers adversary like Russia and likely China as well. A classic mistake based on Sun Tze’s “Art of War” of not knowing your enemy and overestimating one’s own strength.

3. Colonial Powers Going Home: (Fig.11). France capitulated and is pulling out of Niger.

4. Billionaires speaks: First Jamie Dimon, CEO of JP Morgan(the largest and most influential bank in US, now Ray Dalio(Founder of the largest Hedge Fund in the world) gives warning on US Debt Crisis. (Fig. 12). Better spill the beans now then face pitchforks with angry investors and depositors later on.

This week’s financial markets:

A. Stock Market: (Fig. 13): Dow closed at 33,507 for the week, a loss of 456 points or -1.34%. S&P 500 -0.88% and NASDAQ -0.11%.

. The stock market continued to react to Powell’s narrative of a continued tightening but some oversold tech stocks saw short covering activities.Apple (-1.76%), Nvidia (+4.59%) and Microsoft (-0.36%).

B. Debt Market: (Fig. 14): USGG10YR ended the week at 4.579%, a rise of 14.1 basis points. 

Powell’s speech after the FOMC meeting scared a lot of speculative punters who bet on a Fed pivot and went long on a leveraged basis on both stocks and bonds. As sentiment changed, 10YR yield spiked to 4.688% (25 basis points above the previous week’s close, equivalent to a 1.8% drop in the YR10 Note price) on deleveraging before settling back to close the week at 4.579%. UST Yield Curve (Fig. 1) 5continue to see a lifting of long duration as market is being talked into believing that there will be a soft landing or no landing with rates staying higher and longer.

With US GDP growth at 2.1& for Q2 2023 and Fiscal Deficit running at 8.5% of GDP, without spending money which the US does not have and increasingly getting more difficult to borrow, the US economy is already in “deep shxx”. In the meantime, Federal Reserve’s weekly losses now has ballooned up to $105.1 billion. (Fig. 16). So believe the Fed Talk like all the other lemmings at your peril.

C. Commodities and Precious Metals: Trading results for the week: (Fig. 17) Bitcoin (+1.26%), , Uranium (+0.26%), Rmb (-0.04%), NASDAQ (-0.11%), Oil (-0.14%), GBP (--0.33%), JPY( -0.66%), Euro (-0.68%), Rubble (-0.88%), SPX500 (-0.88%), Gold (-3.99%), Silver (-5.82%).

The most interesting aspect of this week’s trading is the take down of precious metals ahead of the Golden Week Holiday in China. As mentioned in the preceding paragraphs, physical gold and silver in China is trading at a persisting premium to the paper LBMA and Comex prices. This practice of taking down precious metal prices when the Shanghai Gold Exchange is closed by paper naked shorts has become somewhat of a ritual as the bag of tricks by the US Exchange Stabilization Fund has her limits. This play is so glaring when the CEO of the largest US Bank and Hedge Fund came out to warn the risk of a debt crisis is looming. But then as they say “there is always a bigger fool”. Here in Australia we have a long weekend to celebrate the King’s birthday and to my friends in Asia, enjoy your long weekend with the Mid Autumn Festival as well.

Proverb 11:1  A false balance is abomination to the LORD: but a just weight is his delight. 2  When pride cometh, then cometh shame: but with the lowly is wisdom. 3  The integrity of the upright shall guide them: but the perverseness of transgressors shall destroy them.