Thursday, May 1, 2008

Bublbes either burst or get slow leaks

On March 24 I posted a Blog that talked about the possibility of two bubbles bursting. The first bubble was commodity prices and the second, I thought would break was the value of the Euro, Pound and the Yen vs. the dollar. Within a month both bubbles have deflated, but I'm not sure we have a burst yet.

The question at the moment is this a "slow leak" or a pause that will re-inflate? The growth rate on a global basis is slowing and Europe and England need to bolster their economies--they, I believe, will start cutting interest rates as a way to try and stem the tide of recession and unemployment. As they reduce interest rates their currencies will fall in reaction to the decline in interest rates. Higher interest rates over seas made these currencies more valuable than the dollar. The demand for the dollar will increase as governments around the world will try and protect their economies by lowering interest rates and find other ways to restore their economies. Keeping growth alive will become more important than defending the currency.

This decline in the value of the currencies has already begun and I expect to see more declines through the summer and into the fall. There will be times when their will be rallies in the bear market for currencies, but I think the trend is down. The implications for the American companies that do business on a global basis is a decline in their earnings in the third and fourth quarters of 2008 and into 2009. When these companies report foreign earnings they will have to report an adjustment downward to reflect to the loss on the currency vs. the dollar.

As the world economies begin to slow down the demand for commodities will decline. Gold is now under under $850 and may be heading much lower perhaps below $800 by Memorial Day. Oil which looked like it was going to $150 may be poised to break $100 by this summer. As commodity prices fall, so will the inflation rate, in the United States. In fact the PCE inflation rate, an important measure for the Federal Reserve, has already started dropping. I wouldn't be surprised that by the fall the talk will be of a greater concern about deflation than inflation.

Let me ask you one question, “can you name an English bank?’-- For that matter how many foreign banks can you name? Can you name one bank in each of all of the countries in Europe? Don’t be embarrassed neither can I. What do you know about the financial strength of any of these banks? The point of these questions is to raise the question about disclosure concerning the financial health of these banks. Do you recall the story about the back office person at a French bank that lost them over $4 billion dollars and didn’t, they said, make any money for himself. I don't think the oversight at the banks in Europe is a strong as it is in the United States. This lack of disclosure may be hiding, for some period of time, some of the problems they have on their balance sheets that haven't come to the surface.

We had problems at US banks and investment banks over the last 9 months. There is no question that hundreds of billions of dollars was lost, but do we know how much money is lost and not reported at foreign banks? I do know that a bank in Bermuda reported a $200 million dollar loss in sub-prime loans in the last 30 days.

The point of this posting is to help you understand that with $300 billion dollars that has been lost do far the problems are not over yet regardless of the headlines. At least for a while the pendulum will swing into more conservative investments less risk and in turn lower rewards to investors.

Dan Perkins

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