FOREX Update: The Dollar and the Importance of TIC Flows

By Bill Jenkins
May 20, 2009

I’ve said it before: the dollar’s chances of long-term success going forward are slim and none... and slim just left town.

Consider the Treasury International Capital (TIC) flow data. TIC measures foreign investment in the United States. This is important because we rely on foreign investors and sovereign governments to continue funding our deficit spending.

But the most recent numbers show a major decrease — $23.2 billion in March, versus an outflow of $91.1 billion the previous month. That will put Ben Bernanke and his boys in an even tougher spot.

Here’s our pal Chuck Butler from EverBank weighing in on this. “There are two ways they can try to entice these foreign investors back into the U.S. Treasury market. They can either let interest rates increase, or let the value of the U.S. dollar fall.

Now which do you think they will choose? They have been running the printing presses on overdrive in order to try and keep interest rates down to create another refinance boom. That tells me the Fed will try to do everything they can to keep interest rates down, so their only option is to let the U.S. dollar fall.”

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The drop in TIC flows, combined with a huge increase in funding requirements by the United States, will have to lead to a general debasing of the U.S. dollar.

That’s not to say things are better on the other side of the Atlantic. The Eurozone (EZ) unveiled some nasty economic news last week.

Let’s start with the real engine of the EZ, Germany. Its first-quarter 2009 GDP number showed a contraction of 3.8%, worse than forecast, and the worst figure since 1970, when these records began. Annually, they are looking at a 6.7% contraction, another record.

In the last nine months, Germany has squandered all of its GDP gains accrued since 2005.

Right on their heels, the EZ composite stats showed a 2.5% GDP drop for the quarter. Again, annualized, that comes in at a 4.6% drop... both of these numbers are records, too.

Expanding our horizons just a bit, we see that Spain continues adding fuel to the fire. Even though Standard & Poor’s has already cut the country’s credit rating, the Spanish folks unveiled their worst recession in four decades. GDP shrank 1.8%, after a 1% drop in the last reading. A year ago, GDP was 2.9% higher. It isn’t a record number, but you’d have to go back 40 years to find something similar.

How much further can Spain fall (and Ireland, and Greece as well) before the euro enters crisis mode?

The truth is, we’ve never been down a road quite like this one. So the map we have is out of date. But there is one thing it can tell us — there is a cliff and a gorge ahead. We just can’t tell how far away it is, or around which bend we’ll find it. No matter, we’ll keep the pedal to the metal, so at least we can make good time getting there...

Adding to the loud accelerating noise in the Eurozone this week, Reuters reports that the European Central Bank (ECB) “has rejected several Central European central banks’ request to accept local currency bonds as collateral,” according to Hungarian central bank’s Kiraly.

Remember that the ECB adopted quantitative easing (QE) — buying bonds — some weeks ago, but there was a significant dissenting vote. Germany’s central bank, the Bundesbank, the most influential in the ECB, was completely against QE.
 
Axel Weber, the Bundesbank’s president, said, “the ECB has done enough to help the economy and shouldn’t consider further measures unless things get a lot worse.” He added, “The ECB doesn’t see the risk of a broad credit crunch or deflation in the euro area.”

I’m pretty sure his counterparts in Spain, Ireland and Greece will take umbrage at his position.

As I’ve written before, the bureaucracy in the EZ makes these decisions and policies tough to carry out. ECB President Jean-Claude Trichet is going to have to work out some kind of ceasefire between the factions. Which means they still have no concrete plan to stimulate anything other than infighting. While this is happening, the euro is speeding closer and closer to the cliff.

Sincerely,
Bill Jenkins

P.S.: We will be continuing to look for cracks in the dam for the dollar. It could be closer than we think…and we’ll keep working to profit from the shorter-term movements that the markets present. Join me and get all of my potentially profitable FX Options trades today...