Good morning,

Yesterday was a boring day… A day of within-range trading. Yet, there is a lot to read from that. Let’s see…
Economic data was deflationary from all corners: A negative Consumer Price Index (worst since 1955, on an annualized basis), a massive increase in inventory of crude oil (5.7MM bb) and low capacity utilization in the U.S. But by the end of the session, oil held above $50/barrel, the S&P500 was at 852 (+1.25%), the CDX IG index (an index of credit default swaps for 125 investment grade names) finished (tighter) at 177bps, and …the VIX (this index measures the implied volatility of S&P 500 index options) closed 4% down!
On the other hand, the Fed was absent and Treasuries traded within range (the 30-yr was down to $96 by noon, but managed to end above $97, with a yield of 3.66%) and in the Agency debt market (Agency debt is a security issued by a U.S. government-sponsored agency), FHLB (Federal Home Loan Banks) priced a new $3BN 2-yr issue at 54bps over 2-yr Treasuries, in an oversubscribed deal.

Perhaps, what caught my attention was the strength of the Canadian dollar, finishing above 83 US cents. I want to believe it was a due to short covering…the same shorts that were looking for weak fundamentals to discredit the recent market action (and were deceived by it).

You ask me what is going on? I think that Investors are in a wait-and-see mode, with increasing concerns over the effectiveness of the Fed’s policies. The question is how long can the Fed keep the long-term yield below, say, 4% by purchasing government debt…At the same time, the coordinated global intervention of central banks leaves investors no currency to escape to. Therefore, in the absence, or perhaps I should say, deliberate destruction of choices, with billions of dollars in monetized deficits, funds are forced to slowly invest in stocks or even oil, in spite of horrible economic data. All currencies are being debased in calculated order. It is precisely this order that is denying gold the chance of playing a safe and lucrative asset.  If the debasement had not been orderly, if it had been amid uncertainty and chaos, gold would have had a chance…This much we can credit Mr. Bernanke & Co.!

After the (positive?) news on the Fed’s Beige Book were released yesterday, we could read that U.S. Treasury Secretary T. Geithner had refrained from labeling China a currency manipulator, among other things. The message was conciliatory, of course. Now, China has been championing the revival of the IMF’s Special Drawing Rights (SDRs), as an alternative international currency.  From my days at the Universidad de Buenos Aires, I remember having read about older discussions on this same idea…

Jacques Rueff (1896-1978) was a French economist that between 1930 and 1934 was Financial Attaché in the French Embassy in London. He was later very influential as well, during the presidency of General Charles de Gaulle. In June 1969, he wrote the following about the IMF’s SDRs:

“…The exorbitant rise in interest rates implies grave dangers for Western prosperity….the cause lays wholly in the fact that those who own funds dislike investments in money, such as short-, medium-, or long-term loans or bonds. Rather than invest in money, they prefer acquiring tangible goods, gold, land, houses, corporate shares…. This preference for tangible goods over assets denominated in currency stems from a feeling that currencies that are all linked to the dollar de facto or de jure are likely, if not certain, to depreciate as a result of the growing insolvency of the two reserve currencies, the dollar and the pound… two sets of solutions have been proposed: those based on the creation ex nihilo of new monetary resources and those implying an increase in the price of gold. As regards the first type…the Triffin plan is the oldest one, while the most elaborate is the “special drawing rights”…These projects have one feature in common: they provide for the creation, by various means, of a new international currency that is defined in terms of gold, but is not reimbursable in gold… Any international monetary crisis, any major outflow of capital, to the extent that they affect powerful countries, will provide an opportunity for an inflationary issue of SDR’s. This in turn will lead to powerful surges of inflation in creditor countries and subsequently over the rest of the world. Thus the creation of special drawing rights, far from allaying fears of inflation, can only aggravate such fears, which at present exacerbate the unwillingness to hold assets denominated in money and the corresponding demand for tangible goods…The SDR scheme will probably be accepted. Governments will “play at special drawing rights” for a few years, just as they played at general arrangements to borrow, swaps, Roosa bonds… But the countries that are adversely affected will rapidly become aware of the injustices and dangers of this new expedient. I hope that first they will endeavor to limit its application as much as possible, and that very soon they will be convinced that another  remedy must be found.” (J. Rueff, “Special Drawing Rights”, June 6, 1969).

Did this read familiar to you?
Have a nice day!