Monday, October 19, 2009


Breaking News
Just wanted to update you on some breaking news related to currency and overseas investing.

Please read the following story from CNBC regarding the Brazilian government preparing to levy a 2% tax on all financial capital inflows.

You Don't Want Our Currency --- Really!
Why would a country do this? What would make Brazil, the shining star of Latin America, take drastic steps to stem the tide of money flowing to their country? They were just given the "honor" to host the 2016 Olympic games, and now they are declaring war on inflows of money?

Well, let's examine the strategies we've highlighted for the past several months. At the end of each monthly analysis I end with the same commentary. "Watch the dollar. If it continues to go down, buy commodities, invest overseas, and buy other currencies." There have been no other themes since my first post here in August.

What are the implications of millions of investors in the US and the world following those exact instructions in one concerted herd-like effort? Simple, as investors shun USD assets like stocks, bonds, and savings accounts that yield nothing, in an attempt to devour off shore investments, we must convert our USD into the foreign legal tender of that nationality. As more and more of our like minded friends pile on, the foreign currency (Real in this case) begins to appreciate in value in comparison to other currencies.

Your Demand for Our Currency Hurts!
Why is this a problem for a country like Brazil? This increase in value of a national currency is a problem for countries like Brazil and Japan because they have many industries that export manufactured goods and raw materials throughout the world. These countries begin to suffer when their currency increases in value because importers that purchase the goods must pay more than they otherwise would for that same good.
A good example is a Japanese company like Toyota. Because the Yen has gone up 20% or more relative to the USD, the Japanese price for the car has technically increased by 20%. Will the US consumer care if a car is 20% more expensive? Heck yes! In reality, Toyota doesn't have a floating car price, so what happens is that the appreciating currency actually causes a loss to Toyota in Japan if they sell a car when those USD are converted to yen. The other solution Toyota has found is that they simply have begun manufacturing cars here in the US to mitigate some of this currency translation issue. Still, if Toyota HQ repatriated ALL of the USD housed here in the United States, the company would take a massive currency loss on the conversion.

Ok, so we can see that if we are a large oil producer or steel producer in Brazil, a rising currency hurts business and slows purchases down as foreign importers begin looking for alternative suppliers. Making matters worse is that the United States also is devaluing its currency on purpose! Emerging markets countries like Brazil get the double whammy as they are suffering from the inflows of all the "created" money looking for a home and the US keeps clobbering its own currency. Do you think many US buyers are actively seeking out purchases of goods and materials in Brazil? The answer is no.

Is It All Bad?
Is it all bad for Brazilians to have a strong currency? No, if they are purchasing imported goods or overseas goods, they seem to be on sale because the purchasing power of their currency is elevated. Think about Europeans coming to New York and Florida buying real estate. The currency exchange rate makes our property seem like it is on cheap.

Let's go back to the article now. What did Brazil suggest that it was going to do to curtail these inflows? Brazil will add a 2% tax on all incoming currency flows. This could slow, if not halt the influx, maybe.

Investment Implications
How exactly might the 2% impact us as investors? If you are an investor in EWZ (Ishares Brazil ETF) you might notice that after hours trading shows that the etf is down $2 or more. While this story is just breaking, I can speculate that new monies flowing into the etf may soon be subject to this 2% tax!!! The ETF takes your investment dollars and purchases ADRs (American Depository Receipts) and stocks in Brazil. It will be quite tough to continue investing directly in the country if every dollar receives an up front 2% hit. Talk about an extraordinary expense ratio!

Does this change mean you run like crazy from EWZ? Perhaps, but it may also mean that we short EWZ for a possible draw down on the news. Even as I type this post, I am not seeing any new news listed under the ticker symbol for EWZ. In addition, any reversal in the dollar will hit EWZ as well.

Why is this important for the United States?
I keep posting on the the weakness of the dollar because it has huge implications for us as investors. Our policy of a weak dollar, (the Fed says we believe in a strong dollar, I know), will have international implications. Brazil is not the first to act as Korea and a few other exporters last week attempted to buy a few billion dollars worth of dollars to reduce the value of their own currencies. Personally, I think the Korean approach is a waste of dollars as I believe strongly that our Fed intends to take our currency much lower. I think t he Brazilian approach is unique and interesting. I'm not sure it will work, but you are really starting to see foreign central bankers try to take action to address the US tactic. Economically speaking, the US is "attacking" these countries and putting pressure on them. You will begin to see increased hostility from exporting nations directed at our country.



  1. Hi, I just discovered your blog via Tim Knight's. I'm with you in the deflation camp (for now). That might reverse one day if the FED keeps pushing on (and something really ugly might result as I'm not sure they can tune everything that fine).

    But I have a question on the $. From your previous posts, I understand that everyone actually sells dollars short (against other currencies) or just buy metals and foreign stocks. Fine with that, I can understand it. But as I see you look at AII for sentiment, there is something similar which applies to forex markets. Right now, there are hardly any dollar bulls out there (and I can understand). Isn't a risk out there that as there are less and less dollar bears the move down will exhaust?

    Next, while I understand there is nothing nice about the dollar, why is there anything nice about the canadian dollar (0.25% rates), swedish krona (negative interest rates), japanese yen (0.1% interest rates), swiss franc (0.5% interest rates), the euro (the balance sheet of the ECB exploded because of spanish and irish banks problems), the british pound, etc. etc. The dollar floats relative to these currencies; what is so nice about the other currencies? Isn't the market to dollar centric while ignoring the other currencies problems? Isn't that dangerous for dollar bears? thanks

  2. I ran accross your blog surfing around, Nice work!!

  3. Dacian -I think we absolutely agree.

    Yes, if everyone leans to the same side of a boat then you tend to flip. I think this is why Prechter, Mish, and others have suddenly gone bullish. When USD bearishness reaches 97% I'm with the smart money and at least temporarily will bet against the herd and go long the dollar. This is why each month I emphasize that we need to be watching the dollar like a hawk because any sustained strength will bring a temporary end to the commodity ramp and equity asset melt up.

    To address your second point, there doesn't have to be anything right or better about the other currencies relative to the USD. The Deflationary post I just made demonstrates that the FED is willing (and has been able) to destroy the dollar's value in the face of a growing clamor by our exporting friends. In fact, they feel like this is the only answer to keep us out of deflation. They feel like administrations in the 1936 and 1937 raised rates too early and they've also stated that Japan was not committed to staving off deflation like they should have.

    You've cited examples of a few countries that are offering similar short term government interest rates, think more that those countries are the "anti-dollar" basket. For foreign investors they must not only worry about the rate you quote, but when investing in the dollar, they must consider the Feds actions that imply they are more than happy to print more and devalue more.
    This is why the Chinese are so over the barrell. They have tons of treasuries and are getting hosed with low rates AND face the risk of further currency losses. This is why we hear they are opting for commodities and physical assets rather than more dollar denominated treasury purchases.

    But let's not try to make things too complex. Sometimes even the herd is correct!

    Thanks for commenting!

  4. Sometime the herd is correct and betting against the herd doesn't always work, I do agree. Now this dollar might keep going down for years, I understand that too, even with so few bulls.

    I'm not a day trader (I'm not a trader at all actually) - I just try to protect my few money I earned the best I can and that is by spending and reading Internet - but if you look at UUP chart, the late weeks volume show some sort of capitulation from dollar holders.

    Now regarding the FED destroying the dollar; I do agree they try hard, but look at BoJ: this is the worst bank in the world as they didn't manage to destroy they own currency! And God knows they tries. How's that possible? I still think the market is too dollar centric; the other central banks do try hard to destroy theirs as well, is just the market doesn't look at those currencies like they watch the dollar.

    Regarding the yen (as I mentioned BoJ), Mish has a statment in a post this week saying Japan has reached critical point and the yen will blow up. What's your opinion here?

    Here is the post from Mish in case you missed it.

    Regarding Mish, Prechter, etc. they didn't go suddenly bullish; they understand the fundamentals of the mess we're in and that's why they keep saying dollar will rebound; lately, their timing (Prechter included) was quite poor on the dollar index. EWI changed their count and they say we're approaching a bottom but the ugly thing with EW theory is that there are so many alternatives :)



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