Don't worry, be happy

Last night (Sydney/Guam time), "U.S. Dollar Trading (USD) was generally stronger across the board against the majors in the overnight foreign exchange trading session. Market participants are worried that the US Federal Reserve will need to increase rates to keep inflation at bay. This view was further strengthened after US Treasury Secretary Henry Paulson said he was in favour of a stronger dollar."

On the other hand, MarketWatch reported, "Higher prices for imported oil pushed the U.S. trade gap of goods and services to a new record in July, a government report showed Tuesday. The nation's trade deficit widened by 5% in July to $68 billion, the Commerce Department said. This beats the previous record of $66.6 billion set last October. Read full government report. The U.S. imported $20.8 billion worth of crude oil in July, the highest amount on record. The import average price per barrel of crude oil was a record $64.84 in the month. The widening of the deficit was larger than expected. The consensus forecast of Wall Street economists had been for the deficit to widen to $65.4 billion. See Economic Calendar. There was little reaction to the trade deficit in financial markets. See full story."

Last night (Sydney/Guam time), "U.S. stocks rallied Tuesday, pushing the Dow Jones Industrial Average to its highest close since mid-May, aided by a sharp fall in crude-oil prices, a drop in bond yields and strong earnings from Goldman Sachs."

On the other hand,

"Financial markets have failed to price in the risk that any one of a host of threats to economic stability could materialise and deliver a massive shock to the world economy, the International Monetary Fund warned yesterday.

The world's chief financial watchdog said the financial system had so far proved resilient in the face of recent price falls but warned the risk of a crash had increased. And when it comes to worrying about a crash in the financial markets that could deliver a body blow to the world economy, it seems that all roads lead to the US.

The IMF highlighted five major risks, all but one of which can be attributed to a greater or lesser extent to the economy and foreign policies of the US administration. Not that the politically savvy IMF phrases it exactly like that.

Its message coincided with a stark warning from HSBC, one of the world's largest investment banks, that it had put the US on alert for "recession risk"."

IMF: risk of global crash is increasing

And John Mauldin reminds us how those various risk factors tend to play out:

"We are in a transition in the world economy, and it sometimes helps to think about how these transitions take place. What is the mechanism for change? Can we see it coming soon enough to avoid the problems and take advantage of them?

... [T]he build-up of critical states, those fingers of instability, is perpetuated even as, and precisely because, we hedge risks. We try to "stabilize" the risks we see, shoring them up with derivatives, emergency plans, insurance, and all manner of risk-control procedures. And by doing so, the economic system can absorb more body blows which would have been severe only a few decades ago. We distribute the risks and the effects of the risk throughout the system.

Yet as we reduce the known risks we see, we lay the seeds for the next 10 sigma event. It is the improbable risks that we do not yet see which will create the next real crisis. It is not that the fingers of instability have been removed from the equation. It is that they are in different places and are not yet seen.

But the longer we go, asserts Minsky, the more likely and violent an "avalanche" is. The more the fingers of instability can build. The more that state of stable disequilibrium can go critical on us."

More on the theme of "fingers of instability".