The Necessary Pain of Cutting Deficit Spending

04/06/11 St. Louis, Missouri – Well… How does a euro (EUR) – that was supposed to be collapsed by now – at 1.43, look? And what do we have here? Political will to do something about the deficit? Well… Maybe… because…

Under the category of “wouldn’t it be nice if we could wake up, in the morning when the day is new, and never have to worry about the deficit, only because it would ruin the whole day through”…
House Republicans unveiled a plan that would cut government spending by $6.2 trillion over 10 years, lower the corporate tax rate to 25%, and dramatically revamp Medicare.
Now… No one, including myself, ever said that making deficit spending cuts was going to be easy, harmless or carefree… They are going to hurt… But, we need to hurt some… Look, once I was diagnosed with cancer, I knew there would be lots of pain, but in the end, it would all be better… Same thing, folks… Same thing… It may not be better for you, but it will better for your kids and grandkids for sure, if we begin to cut deficit spending in a meaningful way!
But… I’m a realist… And I know in my heart of heart, that the plan has a snowball’s chance in hell of passing as is… But if you call your representative and say that you want to see the deficit cut in a meaningful way, you just never know!
OK… So, I started off with a note about the euro gaining to 1.43… Yesterday morning, when it was getting sold, because of the choice of words by Big Ben Bernanke, I told you that it was merely a tempest in a teapot, and that soon the markets would realize that Big Ben wasn’t pulling back the curtain and letting the markets see a rate hike that was on the way… And lo and behold, there he was, bright and early yesterday morning, playing down his words… And as soon as the markets heard that, the rally was on for the currencies once again!
As we draw closer to what might be a HUGE move by the European Central Bank (ECB) tomorrow (rate hike), traders are pushing the envelope on the euro, taking bets that the ECB will indeed hike rates tomorrow, thus widening the rate differential to not only the dollar, but the yen (JPY), and Swiss franc (CHF)! Does a rate hike clear the way for the euro? No… The wolves are always at the euro’s door, folks… The Portugals, Irelands, Italys, Greeces… Every time the euro begins to move forward, one of these deficit-laden countries gets back in the news…
The price of oil moved back above $108 overnight, and has pushed the Canadian dollar/loonie (CAD) to the $1.04 handle, and the Norwegian krone (NOK) to below the 5.44 handle… And the Russian ruble (RUB) just keeps kicking tail and taking names later… I even saw that the Russian government had announced that they would take some oil revenues and reduce their deficit… Now, that’s putting money to good use! Not that I’m advocating going out and backing the truck up to the Russian ruble… But, with oil prices surging, even the ruble gets some love…
The Aussie dollar (AUD) shook off the pain of a wider trade deficit, (it was small), and is back on the rally tracks this morning, as it closes in on $1.04… Do you think that yield differentials don’t mean a hill of beans? Well, check this out kids! Australia auctioned 7-year 5.5% yielding bonds yesterday… The auction was oversubscribed by 5.4 times! And like I’ve a few times now… IF the ECB does hike rates tomorrow, it benefits the countries like Australia that already enjoy rate differentials! Especially if the country that has the rate differential doesn’t come with baggage like Greece!
The Swiss franc continues to get love from all corners of the world. The franc is trading above the $1.09 handle this morning… Geopolitical problems, US and Japan deficit problems, and anything else you can throw in the wheelbarrow of reasons the franc continues to gain value… As long as these problems exist, there’s nothing that the Swiss government or central bank can do to stem the franc’s rise in value…
But the BIG winners yesterday were gold and silver! At one point yesterday, I noticed that gold was up nearly $20 on the day… And silver was trading over $39!!!!! I’ve figured out something that I’ve thought long and hard about … And that is, one would think that rising interest rates (like we might see in the Eurozone tomorrow) would be gold and silver’s kryptonite… But NOOOOOOOOOOO! Here’s the skinny… Rising interest rates are thought to be bad for global growth, and investors turn to the safety of gold and silver!
And did you hear the news about how the US mint is having difficulty finding silver to mint to Eagle coins? I can’t begin to smile like a Cheshire Cat quick enough, folks… Silver is up $14 since I did the story in NewsMax, when I said that I thought that silver had a chance of rising to $50… The way Silver has gained so far this year, $50 looks very conservative!
Getting back to the ECB and the chance of a rate hike tomorrow… Here’s a piece of data that just might sway them toward a rate hike… German Factory Orders for Feb rose 2.4%, which was much stronger than the forecast, which called for a rise of 0.5%! And to top it off, January’s prior print of 2.9% was revised upward to 3.1%! I would have to say that tomorrow, before the ECB meets, Industrial Production for February will print, and with this strong of a Factory Orders print, one would have to think that Industrial Production will also surprise on the upside… Having that news right before the ECB votes just might be enough to push the ECB ministers to hike rates…
Yesterday, I told you about the fresher-than-fresh news that China had announced yet another rate hike. Now, as I look at it, this is the fourth rate hike by China, so by now, the economy should be moderating… And if it isn’t, it will… But, speculators that drive the forward points on renminbi (CNY) (remember forward points are what you pay for buying renminbi in the forward market, in other words, any day past spot, which is two days), are continuing to push the envelope on renminbi forward points, which means they aren’t buying the “rate hikes will moderate growth” rhetoric… I don’t know what they “know” or what they are smoking, but speculators just aren’t buying the moderation story for China’s economy… And when they drive the forward points higher, it just makes it that more expensive to buy renminbi!
The New Zealand dollar/kiwi (NZD), had a strong performance last night. And even though the Reserve Bank of New Zealand (RBNZ) had cut rates last month to assist the earthquake ravaged economy, interest rates are still higher in New Zealand than they are in the US and Japan… And like I said above, and several times lately… Interest rate differentials are the driver right now… It’s been some time since interest rate differentials played the leading man, in currency valuations, but the old man is making a comeback… Come on back old man, I’ve missed you!
And the selling of Japanese yen continues, folks… The yen has lost 3.3% in the past month, and I just don’t see this being a short-term move… So, in other words, I don’t like yen… Yes, Mother Nature dealt Japan a blow. Unfortunately for the yen. You see, Japan is going to have to keep rates at zero, inject more deficit spending, and none of that is going to help the yen…
Then there was this… Here’s a report that can be viewed a couple of different ways… The report said that personal income in 2010 rose…
Hmmm… Well, with 23% unemployment, one has to wonder how that happens, right? Well, you can always count on me to explain things so that the masses aren’t confused! Basically, those of us who had jobs saw our income rise… (Maybe you did, but I sure didn’t! UGH!) So, on paper, incomes rose… But in reality, they probably rose for the most part due to longer hours worked by those remaining in the work force! So, before your local politician begins to pound his chest and say that his constituents saw their personal income rise in 2010, you might want to elbow him and point out the facts…
Chuck Butler
for The Daily Reckoning
Chuck Butler is President of EverBank® World Markets and the author of the popular Daily Pfennig newsletter, which is reposted here at The Daily Reckoning. With a career in investment services and currencies extending over 35 years, Mr. Butler oversees all aspects of customer service and the trading desk for EverBank World Markets. A respected analyst of the currency market, Mr. Butler has frequently made appearances or been quoted by the national media. These include the Wall Street Journal, US News and World Report, MarketWatch, USAToday, CNNfn, Bloomberg TV, CNBC, and the Chicago Tribune. Mr. Butler was previously the Chief International Bond Trader and Director of Risk Management for Mark Twain Bank, and has held significant positions in the investment industry since 1973.
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