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Mark's Market Blog

8-23-15: The Coming Dollar Short Squeeze

By Mark Lawrence

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The Shanghai index is back down to 3500 - the level where twice before the Chinese government has stepped in and propped it up. Commodities, especially oil and copper, continue to fall. China's manufacturing came out and were numbers exceptionally poor. In anticipation of the end of the world, US stock markets dropped below their 200 day moving average and their support levels, down 7.5% from the peak a month ago. The VIX, the volatility or so-called fear index, is at 28, the highest it's been since August 2011 when it hit 42. Is this the long-awaited 10%+ correction? Sorry, I'm out of the predicting corrections game. I will say you have to go back to August 2011 to find a drop this steep. That month saw an 18% correction followed by two months of oscillation. I will also say it's not the end of the world, and I continue to think US markets will end the year higher. Housing starts, house prices and house sales are all up, and that's a huge indicator that the overall US economy is ok.


S&P 500 February 28 2014 to August 21 2015

I've been saying for several years that the US seems to be following a policy of printing money, importing deflation and exporting financial chaos with the goal of being the last man standing. Now it's starting to look like that's coming to fruition - stock markets, oil, commodities, real estate are dropping all over the world. Mexico, Brazil, Venezuela, Chili, Columbia, Russia, the various stans are all in trouble. There's $9 trillion outstanding in US dollar denominated bonds, where $7 trillion of that has neither a US borrower nor a US lender. Those companies almost certainly have no substantial US revenue stream, so as the dollar continues to strengthen this debt looks more and more overwhelming in the local currency. When they have to buy dollars to service the debt it's going to get very painful. And there's no central bank backing these bonds, no lender of last resort - when liquidity dries up, too bad, the dollar will shoot through the roof and there will be blood in many foreign streets. This is going to lead to a short squeeze on the US dollar - foreigners are going to find themselves short of dollars and desperate to sell anything to buy dollars. Why do I call this a short squeeze? Imagine you live and work in, say, Brazil. You sell some dollar denominated bonds, meaning people give you dollars now in return for your promise to give them back dollars later. You're making a bet that later the dollar will be no stronger than it is now. If it the dollar goes up, you're in a classic short squeeze: you bet something was going down, and it went up. A simple analysis leads to the result that foreign stock markets are over valued compared to credit default swaps by 40%, so either credit default swaps have to get a lot cheaper (the dollar crashes: not bloody likely) or foreign stock exchanges have to drop precipitously ( <-- this one).

What happens to the US in such a short squeeze? This is not new: we played this game in the early 80s causing the Latin American crisis; in the mid 90s we did it again leading to the Mexican, then Asian, then Russian crises, culminating in the LTCM crash that almost brought down Wall Street. The last two times we did this we were lowering interest rates while the short squeeze was going on. This time our rates are already at zero and the Fed is getting ready to raise rates. Our markets went down pretty much non-stop during the first short squeeze from the late 70s to the early 80s; our markets went up pretty much non-stop during the second short squeeze in the late 90s. This short squeeze will make everything else in the world seem cheap and wipe out US inflation, likely leaving us in a strongly deflationary environment. As this unfolds the Fed will be forced to hold rates low to combat the deflation. Since debt itself is deflationary - you can't spend money on consumption if you're spending your money on debt service - low rates will help in the short run but drive us further into deflation in the long run. Who is at greatest risk? South America and Asia, as usual, are holding 'way too much US dollar denominated debt. And any country that generates substantial income on commodities, like Canada, Australia and the Arabs. Another year or two of this and Goldman Sachs, Warren Buffet and JP Morgan will be ready to step in and buy up entire small countries. And we're going to hear from many countries how we're waging economic war on them. They will be right: the top .001%, the world's billionaire narcissist oligarchs, will be doing just exactly that. This time is different, I think. The last two times we did this I think it was by accident. However this time I think it is by design. Five years ago I was told about this last-man-standing end game by a quantitative analyst who worked for HSBC. Now I'm watching it unfold. Not a coincidence.

Copper is down to $5000 / ton for the first time since the 2008 crisis. This means there are few major construction projects, especially in China. Commodity sales don't lie. Oil is below $40; some think it will stall there, some think it will continue down until it hits 30 or even lower. US and Saudi oil production are both at record levels, and estimates are that in three more months the world will be running out of storage room for excess oil. Before China went on their building spree in 2000 oil was relatively stable around $20-$30; if China is done building bridges to nowhere, airports where no one lands, and cities where no one lives, perhaps oil will return to $20-$30. In the 90s before the China build-out copper was stable around $2000 / ton. It's very possible that commodities have a lot further to fall. Will the Fed raise rates in this environment? My Fed crystal ball is quite cloudy. All I know is here in the P.R. of California I'm still paying $3 / gallon for gas.

Will the Fed raise rates in September? Maybe not. This last week has seen some major damage done to markets all over the world. Oil continues to drop and the outlook seems to be that it will drop further. Oil prices and inflation track each other closely - no surprise to those who maintain the inflation of the 70s was due to the emergence of OPEC, not due to LBJ's and Nixon's bad economic policies. The July Fed minutes came out and there's a lot of dovish voices. It would be unsurprising if the Fed decided to delay until December to see how things played out. If that happens expect a boost in the market for October and November as the drunken party continues.

Canada is clearly having a major housing bubble, where house prices are climbing to absurd levels compared to average family incomes and people believe you always make money on a house. Some think that bubble will be bursting soon, like this year. I don't. Canada is entering a recession and I expect their central bank to cut interest rates and start up their own QE program. We all know what low interest rates and loose money does to house prices. Canada is setting themselves up for some major problems down the road a year or two from now. imho.

Greece's PM Tsipras has resigned and called for new elections. He sure likes to have Greek people voting a lot. He's likely to win again, so this appears to be an exercise in changing coalition members. Tsipras' socialist roots have always been at odds with Greece's demand to remain in the Euro; now that contradiction seems to be splitting Tsipras' party, Syreza. Europe is unhappy over yet more drama and yet more uncertainty.

The US has been bombing a large factory in ISIL's territory that manufactures and stores car bombs - one of ISILs biggest weapons. We're very proud of our precision bombing and making noise about the huge damage we're doing to ISIL. It's worth remembering that no war has ever been won by bombardment - eventually you have to put feet on the ground. Germany's industrial output increased every single year during WW II in spite of ferocious allied bombing. Personally, I continue to think ISIL is winning.

Illinois has failed to appropriate money to a trustee, money earmarked to make a payment on some bonds. They have the money available to make this appropriation but their congress failed their July 1 deadline for a budget. Illinois is, at this instant, in technical default. I imagine the way to bet is that a budget will pass, money will be appropriated, and the technical default will be cured. I imagine that. I also used to hide chocolates telling my kids the Easter Bunny left them, so you may feel free to decide I have an over-active imagination. Illinois is most certainly walking the ragged edge and a misstep could be ruinous.

There's a part of the world that's desert, muslim, and headed for environmental catastrophe. Kazakhstan, Kyrgyzstan, Uzbekistan, and northwest China get their water from glaciers in the Himalayas. The glaciers on the Himalayas are melting quickly - they're 27% gone, and by 2050 they may be functionally gone. So in the next 35 years there's a distinct possibility that a huge swath of this part of the world will be uninhabitable. I personally intend to stand outside of Walmart and see if I can collect donations to help these moderate muslims relocate to more habitable countries, where they can assimilate, get educated, become productive and live in peace. And get chocolates from the Easter Bunny.

Free extra, joke of the month:
A guy walks into a muslim bookstore and says, "Do you have Donald Trump's new book on Muslim and Mexican immigration?"

The shop keeper turns red and says "What the @#*$&^ ?!?! You're not welcome here. Get the *(&#^$ out and don't come back!"

The guy says, "Yah! That's the book! Do you have it in paperback?"

There was a chemical explosion in China which killed at least 114 people and injured several hundred more. China has a law that dangerous chemicals cannot be stored within 1000 yards of residential property; this warehouse was within 500 yards and operating without proper permits. There were over 2500 tons of chemicals in the plant including ammonium nitrate, potassium nitrate, sodium and magnesium, and 700 tons of deadly poisons, mainly sodium cyanide. Cyanide levels in the port waters are now 277 times normal, but the government claims drinking water is still safe. 17,000 apartments were damaged. A Chinese newspaper reports that since the explosion inspections of 124 other firms handling dangerous chemicals found that 85 had safety hazards. Next time you're thinking of eating something made in China, remember this is the country that poisons their own children's milk, kills 5,000 people each day due to air pollution and has cyanide levels 277 times their own standards of acceptable; how much do you really think they care about you?

China's Shanghai Index dropped 11% this week to the 3500 level where previously the government has stepped in and propped it up. It seems clear the market wants to keep dropping. China's PMI is down to 47.1, deep in recession territory. We may expect another Chinese rate cut soon; if that's coupled with a US rate increase Chinese money will only flee faster. Can China hold this market up indefinitely? Perhaps - this is China we're talking about, in the extreme case they can simply shut the market down or buy all the shares. However they can only spend their $3.5 trillion in reserves once and that money won't last forever. Some say China can't crash because of their reserves. I say they can't crash until the reserves are nearly spent, and that's now looking like it's only a year or three away. They have major structural problems and loaning out more money on questionable building projects and dying companies and banks makes those problems worse, not better.

China's devaluation is starting to be met by other countries - Kazakhstan, Turkey, India, Vietnam, Malaysia, Indonesia, Taiwan, Japan and Korea all lowered their currencies since China acted last week. If the Fed goes ahead and raises rates in September there will be the start of major capital flight from the 3rd world and there's a good chance all out currency warfare will happen. China appears to have a cold and most of the world looks ready to call in sick. What will this do to the US? Not so much. The US direct investment in Ireland is six times that in China. We import a lot from China but that just got cheaper. They have about $1.2 trillion of US treasury notes and they're likely to continue to sell some of those, but there's a huge market in t-bills and we'll never notice that. GM will sell fewer Buicks in China (they sell more Buicks in China than in the US), but soon GM will be importing Buicks from China to the US and getting a better deal on the cost. China never did import much of anything from the US besides stolen military and industry secrets, so whatever happens to them will have little to do with our major companies. So all this market panic this week about China is, imho, overblown. For us. The rest of Asia and South America, this is not so good for them.

In 2008 HP bought EDS, Ross Perot's consulting company, and promptly doubled their employment. GM had bought EDS in 1984 then sold it back to Ross at a huge loss in 1996. HP isn't doing so well either - EDS revenue has been shrinking by double digits year on year for a long time. HP announced a reorganization in 2012, substantially aimed at restoring EDS to financial health; they've laid off 55,000 workers since and have more to go. Ross is 87, I doubt he'll be buying it back again.

The National Labor Relations Board is going to rule, possibly next week, on claims that companies that hire other firms to provide labor have an employer-employee relationship with the workers brought in by those firms. This means McDonalds would be effective employers of people hired by the franchises and companies that use temp firms are employing the temp workers. This would have a profound effect on Obamacare and on union membership. Since the NLRB is dominated by democrats many expect them to rule in favor of Obamacare and unions.

Scientists have announced that they have linked a particular gene, FTO, to obesity. People with two copies of this gene, one from each parent, weigh 7 pounds more on average than people who don't have it. They hope to have a drug in a few years. Bad news, boys: obesity is caused by fats, oils and sugar. We'll get thin again when we clean up our diet. I'm not holding my breath: the population on the whole loves french fries, fried chicken, doughnuts and oreos. And the magic gene? In the US the group with the biggest obesity problem is blacks, but only 5% of the black population has this gene.

Is solar power for you? Google has a new web site that will help you run the numbers. They calculate the amount of your roof that gets sunlight, how much power you can generate, how much money you'll save compared to your local utility. They're still gathering data so it seems they're not ready for most addresses.

Ashley Madison - the web site for cheating when you're married - has been hacked severely. More than 35,000,000 names and emails and associated sexual preferences have been released publicly. So much for anonymous membership. The press is still combing through the names, but several famous people have already been found seeking some extra-marital action. Canada is starting a class action law suit seeking damages which are approximately seven times the entire company's revenue. The UK is readying similar a lawsuit apparently seeking damages of about sixteen times the company's income. Of course the US is the place for class action lawsuits - none has been filed yet, but that's only a matter of time. Divorce lawyers all over the world are saying that Christmas comes in September this year for them as people find their spouse's name in the data and blow up. Blackmailers are also trolling the names - emails are already going out with demands for money from a group that calls itself Team GrayFlay. I'm not married and I have zero interest in having an affair with someone who is, so I guarantee I won't be having any trouble from this. As for Ashley-Madison's 35 million suddenly very public customers, karma's a bitch. Hate your spouse? Get a divorce.

World population continues to grow. Essentially all the growth projected for this century is in Africa and India; pretty much everyone else has a shrinking population. Asia's graph would show a much steeper decline absent India. Meanwhile Bill Gates has dedicated his time, intellect and fortune to improving the health and breeding potential of precisely this group. I'd be ok with that if he was also handing out free IUDs and implants.

Here are the 25 biggest "unicorns," privately held startups that are worth more than a billion dollars. Notice that almost all of them are aimed at taking away business from banks. Goldman Sachs, Citi, Bank of America and JP Morgan are going to wind up being forced to step out from behind the banking curtain and be revealed as the stock, bond and currency market manipulators they really are.


25. Mozido, a mobile payment and wallet provider
24. TransferWise, an international money transfer service
23. Jimubox, a Chinese peer-to-peer loan provider
22. Funding Circle, a peer-to-peer loan platform for small businesses
21. Qufenqi, lets Chinese consumers buy electronics in instalments
20. Housing.com, online Indian real estate platform
19. SoFi, a marketplace for student loan refinancing
18. iZettle, makes card readers for smartphones
17. Xero, makes cloud-based accountancy software for small businesses
16. Adyen, an online payment processor?
15. Oscar Health, online health insurance
14. FinancialForce.com, sells cloud-based accounting apps
13. Zuora, software that lets companies take subscriptions
12. Prosper, a peer-to-peer lending platform for consumers
11. One97, India's Paypal
10. CommonBond, a peer-to-peer student loans marketplace
9. Klarna, Swedish online payment processing
8. Powa Technologies, makes mobile payment products
7. Credit Karma, free credit scores
6. Zenefits, free HR software for small businesses
5. Lending Club, America's biggest peer-to-peer consumer loans platform
4. Stripe, online payment processing
3. Markit, financial information and data provider
2. Square, smartphone card readers, small business loans, and online payments
1. Lufax, Chinese peer-to-peer lender

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