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ACTIONS, REACTIONS AND DISTRACTIONS

Much has happened in the past 7 days. In the U.S.A., Democrats have retaken both the House and Senate for the first time since 1994. On a macro/geo-economic level – this move is almost universally viewed as being a shift toward advocacy of “fair trade” as opposed to unbridled “free trade.” In econo-speak this is referred to as a move toward protectionism.

While the extent to which the U.S. actually does or does not follow through with legislation in this regard – there has already been fallout, or perhaps more accurately stated – “a shot over the bow” – from America’s biggest beneficiary of free trade. Take special note of the timing – November 9, two days after the American mid-term elections – of People’s Bank of China head, Zhou Xiaochuan,

"All central banks are trying to diversify," People's Bank of China Governor Zhou Xiaochuan said at a conference in Frankfurt. "We have had a very clear diversification plan for several years."

The reaction to these words [the political message] in international markets was swift; the U.S. Dollar Index initially cratered, then recovered.

And the price of gold surged after initially being “bashed” in early morning London trade, only to collapse Friday and again today.

Now I’m going to go out on a limb and suggest that the following “olive branch” was a peace offering to the international financial fraternity this past Friday - from the besieged Bush Administration – to help smooth over the protectionist tilt of the mid term elections. The notion that this was indeed an olive branch is reinforced by its receiving “ZERO PRESS” in the cooperative [or, co-opted perhaps?] American media but did warrant mention in the British Press:

Russia and US poised for WTO deal
BBC News, Nov 10, 2006

Russia has finally cleared the last hurdle in its bid to join the World Trade Organisation (WTO).

The US has agreed in principle to approve Russia's membership, after holding out in lengthy bilateral talks

Russia and the US hope to sign a WTO accession deal at the Asia-Pacific Economic Cooperation summit in Vietnam next week...

A breakthrough like the accession of Russia to the Word Trade Organisation [WTO] – one might logically think - would normally be a prominent front page financial news item. Well, let’s just say this story did garner coverage in China and Russia, too – but curiously none in North America.

Perhaps this was not the kind of message the Republicans wanted “splashed” across headlines on the heels of an election all about change.

This past week also saw Mr. Ben Bernanke give a speech to the Fourth ECB Central Banking Conference, Frankfurt, Germany, November 10, 2006. The title of the esteemed Chairman’s speech was, 'Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective.' Its text is linked here. The gist of the speech seems to diminish the significance of monetary aggregates and to therefore justify the Fed’s discontinuance of publishing M3 Money Supply aggregates.

“….However, the Federal Reserve discontinued the procedure based on non-borrowed reserves in 1982. It would be fair to say that monetary and credit aggregates have not played a central role in the formulation of U.S. monetary policy since that time, although policymakers continue to use monetary data as a source of information about the state of the economy.”

The passage in Mr. Bernanke’s speech cited above, I can personally dispute from my own personal experience as a broker of Euro Dollar Deposits on a trading desk between the years of 1982 and 1990 – I can attest to the fact that monetary aggregates – particularly M3 – were the most watched of all economic data sets published by monetary authorities between 1982 and 1987. I know this from my personal experience as these numbers used to be released at 4:30 p.m. ET on Thursdays – the economic highlight of each and every week back in those days.

Whether or not Mr. Bernanke has his facts and figures straight on the importance of and how widely followed Money Supply Aggregates were during the 1980’s is – in my experience – an historical fact. Why he was not made aware of this while he taught at Stanford University from 1979 until 1985 is another question altogether.

What we can discern is that European Central Bank [ECB] President, Jean-Claude Trichet does not appear to share the same view of the importance of Money Supply Aggregates as Mr. Bernanke,

“ECB President Jean-Claude Trichet, by contrast, wrote yesterday in the Financial Times that "a model of monetary policy that includes no role for money is incomplete." The ECB "cross checks" its economic analysis every month with figures on money and credit growth before making a decision on interest rates."

I bring all of this to your attention for a couple of reasons:

First, these developments are U.S. Dollar negative and yet, the dollar has suffered relatively no pain – in fact, it’s curiously made smart gains today. Gold, which initially surged in price on Xiaochuan’s comments, has been subsequently bashed. Appearances can be deceiving, so act accordingly.

Second, these developments [apparent rift between thinking of Bankers, Bernanke and Trichet and waning support from China] could potentially be quite damaging to the bond market – meaning higher interest rates could be in the offing – yet, U.S. interest rates have declined smartly since the election, albeit up today. So once again, act accordingly if you currently have exposure to variable rate “floating” mortgage debt.

Today’s Market

Overseas equity markets began the week on a sour note with Japan’s Nikkei Index falling 90 points to close at 16,022. Meanwhile, North American markets bucked that trend and began the week with solid gains. The DOW was ahead by 23.45 to 12,131.88, the NASDAQ up 16.70 to 2,406.40 and the S & P up 3.50 to 1,384.40. NYMEX crude oil futures fell 1.01 to 58.57.

In foreign exchange – the U.S. Dollar Index gained .31 to 85.19.

Interest rates were 2 – 3 basis points higher across the curve with the 2-year bond ending the day at 4.76%, the 5-year at 4.59% and the 10-year bond ending the day at 4.61%.

Precious metals were beaten up today with COMEX gold futures ending the day down 4.00 to 625.20 per ounce and COMEX silver futures lost .19 to end the day at 12.92 per ounce. The XAU lost .29 to 137.92 and the HUI gave up .99 to 331.40.

On tap for tomorrow:                                                                                                                   

Wishing you all a pleasant evening and a happy and prosperous tomorrow!

Rob Kirby

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