Tag Archives: Dollar

Why QE3 will fail, and why that may be very good for the U.S. dollar

by Jack Crooks

Jack Crooks

It seems to me the Great Depression has cast a long dark shadow over Fed Chairman Ben Bernanke’s thinking. The man seems obsessed by the idea, based on his own historical research that if the Fed had just done “more” the Great Depression could have been avoided.

I think he is dead wrong. And in fact it was the Fed that, through money and credit manipulation, set the stage that caused the Great Depression.

Mr. Bernanke gave a summary of why he believes the Fed was at fault for allowing the depression to become “Great” in a speech he gave back in 2004, “Money, Gold, and the Great Depression.” This speech provides an excellent insight into Mr. Bernanke’s core beliefs. Here are a few key excerpts:

During the first decades after the Depression, most economists looked to developments on the real side of the economy for explanations, rather than to monetary factors. Some argued, for example, that overinvestment and overbuilding had taken place during the ebullient 1920s, leading to a crash when the returns on those investments proved to be less than expected.

… To support their view that monetary forces caused the Great Depression, Friedman and Schwartz revisited the historical record and identified a series of errors—errors of both commission and omission—made by the Federal Reserve in the late 1920s and early 1930s. According to Friedman and Schwartz, each of these policy mistakes led to an undesirable tightening of monetary policy, as reflected in sharp declines in the money supply. Drawing on their historical evidence about the effects of money on the economy, Friedman and Schwartz argued that the declines in the money stock generated by Fed actions—or inactions—could account for the drops in prices and output that subsequently occurred.

… The transmission of monetary tightening through the gold standard also addresses the question of whether changes in the money supply helped cause the Depression or were simply a passive response to the declines in income and prices. Countries on the gold standard were often forced to contract their money supplies because of policy developments in other countries, not because of domestic events. The fact that these contractions in money supplies were invariably followed by declines in output and prices suggests that money was more a cause than an effect of the economic collapse in those countries.

This is a powerful defense for monetary easing. But by any measure, it seems that goal of increasing money and monetary supply to cure economic ills has already been achieved by Mr. Bernanke and Company. And they are fighting a losing battle.

As you can see in the chart below, bank reserves are in the ozone.

Chart 1

What’s more, the money supply is still trending higher …

Chart 2

But all that money is NOT stimulating the economy! The plunging rate Americans are spending is clearly shown in the following chart. I believe this drop is due to changing consumption/savings patterns as U.S. consumers attempt to recover from this serious balance sheet recession, similar to the experience of the Great Depression.

Chart 3

And so far, historically low interest rates by the industrial world central banks haven’t done diddlysquat for the unemployed.

Chart 4

Simply put, Mr. Bernanke must fix the plumbing before any amount of money is going to improve the real economy! The mechanism that transmits credit into the real economy is broken. And pushing rates lower only exacerbates the problem domestically and creates monetary tensions overseas.

What It Means for the Dollar

At first blush all this quantitative easing looks very bad for the U.S. dollar. And it has been to a large degree. But because QE3 actually retards the ability of the real economy in the U.S. to grow, it has a massive negative feedback on Europe and China; both require strong U.S. demand to export.

So in a sense, a very bad sense, QE3 may be very good for the U.S. dollar as it will likely trigger a major change in risk appetite for global assets markets. And that could happen once sentiment shifts and people realize that history shows there is much more to reviving a complex system such as the global economy than through pure money and credit manipulation.

And at some point, the liquidity-driven financial markets will reflect the very poor conditions of the underlying real economy here and abroad.

Best wishes,

Jack

Source: http://www.moneyandmarkets.com

How Long Will the Dollar Remain the World’s Reserve Currency?

green dollar sign

We frequently hear the financial press refer to the U.S. dollar as the “world’s reserve currency,” implying that our dollar will always retain its value in an ever shifting world economy.  But this is a dangerous and mistaken assumption.

Since August 15, 1971, when President Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold, the U.S. dollar has operated as a pure fiat currency.  This means the dollar became an article of faith in the continued stability and might of the U.S. government.

In essence, we declared our insolvency in 1971.   Everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it– not even a pretense of gold convertibility! Realizing the world was embarking on something new and mind-boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC in the 1970s to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence backed the dollar with oil.

In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite radical Islamic movements among those who resented our influence in the region. The arrangement also gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as the dollar flourished.

In 2003, however, Iran began pricing its oil exports in Euro for Asian and European buyers.  The Iranian government also opened an oil bourse in 2008 on the island of Kish in the Persian Gulf for the express purpose of trading oil in Euro and other currencies. In 2009 Iran completely ceased any oil transactions in U.S. dollars.  These actions by the second largest OPEC oil producer pose a direct threat to the continued status of our dollar as the world’s reserve currency, a threat which partially explains our ongoing hostility toward Tehran.

While the erosion of our petrodollar agreement with OPEC certainly threatens the dollar’s status in the Middle East, an even larger threat resides in the Far East.  Our greatest benefactors for the last twenty years– Asian central banks– have lost their appetite for holding U.S. dollars.  China, Japan, and Asia in general have been happy to hold U.S. debt instruments in recent decades, but they will not prop up our spending habits forever.  Foreign central banks understand that American leaders do not have the discipline to maintain a stable currency.

If we act now to replace the fiat system with a stable dollar backed by precious metals or commodities, the dollar can regain its status as the safest store of value among all government currencies.  If not, the rest of the world will abandon the dollar as the global reserve currency.

Both Congress and American consumers will then find borrowing a dramatically more expensive proposition. Remember, our entire consumption economy is based on the willingness of foreigners to hold U.S. debt.  We face a reordering of the entire world economy if the federal government cannot print, borrow, and spend money at a rate that satisfies its endless appetite for deficit spending.

Ron Paul

Dollar Demise Continues – China, Japan to Use Yen, Yuan and Not the USD

It looks like the US Dollar is about to be dealt another blow. Although it won’t be a deadly blow it definitely is not good for the long term success of what is now still the world’s major reserve currency.  I came across an article on the GoldSeek website that talks about how Japan and China will stop using the US Dollar to conduct trade with each other.  Time to short the US Dollar? Perhaps so!

Details can be read in the republished article.

Article follows below. Enjoy.

In the next month China and Japan (China’s main trading partner) will no longer use the U.S. dollar as the only currency in trade with each other. They will use the Yuan and the Yen directly with each other. This will see the dollar removed from a large chunk of the world’s trade –in itself, not a very large percentage, but a significant one. It’s the start of a trend that is set to grow. We’ve no doubt that China is tailoring its trade with all its trading partners to use the dollar only so far as it is required to deal with the U.S. and other dollar-dependent nations. Oil from Russia utilizes the Yuan and Rouble, and Australia has arranged a similar deal.

The purpose of foreign exchange and gold reserves is to provide ‘global money’ (which includes gold) for potential rainy days. China will therefore build up reserves in all the currencies that it will trade in. All this will take place at the expense of the dollar. Currently the U.S. dollar is used in around 76% of the world’s trade. More importantly for the dollar, its use as a reserve currency (it currently comprises 63% of global reserves) will diminish in line with the growth of Yuan/ other currencies.

Currencies in Japanese/Chinese Trade

To explain the process more clearly, when a Chinese company buys goods from Japan, it sells Yuan and buys dollars in its place, for delivery to the Japanese supplier. The Japanese supplier then sells the dollars for Yen. This brings many risks to the transaction because both the Yen and the Yuan are constantly moving against the dollar and the dollar is driven by its own economy and pressures. By going direct, these risks and extra costs are eliminated. Likewise the influence of the U.S. over global trade is diminished, for this trade will no longer require the vast amount of trade to go ‘via New York’.

U.S. Power and Influence Changing

Earlier this month, we produced an article that discussed the purchase of Iranian oil in the Yuan and Indian Rupee. U.S. influence and power over world oil supplies has been complete because of the sole use of the U.S. dollar in the oil price. But when Iran dropped the dollar from its oil sales, this power was undermined. The U.S. tried to bring India and China on board in punishing Iran –over its nuclear developments— but had extremely limited success. The U.S. then used the SWIFT system of banking alongside its own banking system to block Iranian oil sales and their payments. China and India used their own currencies and clearing systems to bypass these blockades. As we pointed out in the earlier article, this was not simply a financial development but a shift in power to the East. The Iran story highlights the importance of the development of the Yuan’s growing use.

China’s viewpoint is not to challenge or attack the U.S. but to develop systems that will be in its own interests and independent of outside political or financial influences. Unhappily for the U.S. this is leading to the decline in U.S. power, both politically and financially. With China and the emerging world accounting for over half of the world’s population, the potential growth here will mean an eventual huge curtailment in U.S. power and influence. The agreement with Japan marks a major step forward in this process.

Fragmentation of the Present Monetary System

Since the Second World War and through the Bretton Woods system to today’s monetary system, the dollar and the U.S., with its power and wealth, has ensured its continued success, sometimes against basic fundamental reasoning –such as the ability of the U.S. to just print dollar to cover its Trade Deficits on an ongoing basis, a sort of Tax on the rest of the world. Indeed, the dollar, with its link to oil, is the tree-trunk of world money with all other currencies acting almost as branches growing out of that tree. The steps being taken by China now is another tree (currently a sapling) growing alongside it and eventually no longer dependent on it. The worry is that this new tree is sapping the old tree of its strength. We are certain that China will do all in its power to ensure it minimizes the influence the U.S. has over its financial system.

The dangerous period for the two trees is when the new sapling is not strong enough to stand alone and the old tree is ailing. This is the time when support is needed for both. That support has to be independent of both for it to give effective support. That support must convince all in the monetary world that it will give enough inherent strength to shore up the weaknesses of both. But at the same time this support must be a common denominator throughout the financial world.

If the transition of power and through changes is smooth, then a new shape to the world’s money will be easily accepted. But in all of man’s history, such transitions have been far from smooth or peaceful; they’ve been marred by confrontation and breakdown and usually both. We see this future for the monetary world in the face of these developments.

With the debt debacles on both sides of the Atlantic, the developed world’s monetary system is vulnerable to such pressures as never before. The monetary system now faces structural pressures that are bound to lead to turmoil and deeper crises, not simply inside nations, but ones that will shake up global foreign exchanges and breed more and more uncertainty. The last few years of financial crises in the developed world will seem tame by comparison. The separate interests of the developed world and the emerging world will emphasize the uncertainty and lack of confidence that will hang like a cloud over the world’s changing money systems.

Source: Goldseek.com

U.S. Dollar & Currencies: Review and Outlook

Axel Merk & Kieran Osborne, CFA, Merk Funds

In 2012, policy makers around the world may be driven by the realization that the theme of 2011 was not a Euro-specific crisis, but simply another stage in a global financial crisis. Central bankers may ramp up their printing presses in an effort to limit “contagion” concerns. As such, the currency markets may be the purest way to take a view on the “mania” of policy makers. Market movements may continue to be largely driven by political rhetoric, rather than company earnings announcements or economic data. We don’t believe this trend will abate over the foreseeable future, especially given the likely leadership changes throughout several G-7 nations.

The primary motivating force behind politicians’ decision-making may be quite different, and more often than not, at odds with those of the broader market or sound economic fundamentals. Moreover, we have witnessed an unprecedented period of political posturing and increased polarization of views. This has only served to underpin the increased levels of market volatility experienced in 2011.

Central banks of the U.S., Japan and the U.K. have shown they are most willing to put in place expansionary policies. For one, there will be a more dovish composition of Federal Open Market Committee (FOMC) voting members in 2012. Many Western and Asian policy makers have already begun to ease. From a currency perspective, we believe these dynamics will serve to benefit the currencies of commodity producing nations, while underpinning Asian economic growth.

Local agitations…

The European sovereign debt crisis dominated headlines for much of 2011. Market practitioners traded on the back of any change in sentiment regarding the ability of policy makers to put in place comprehensive measures to address the issues. Initially focused on the nations of Greece, Ireland, Italy, Portugal and Spain, the crisis quickly grew to engulf many core European countries, even having an effect on stalwart Germany, which suffered a failed bond auction towards the end of the year. Nonetheless, sovereign spreads over corresponding German bunds were used as a bellwether for market-ascribed fiscal health of European countries; we saw many spreads widen markedly during 2011.

Any communication from Germany (Merkel) and France (Sarkozy) was closely watched. Colloquially known as “Merkozy,” the two leaders took it upon themselves to meet ahead of important EU summits to set the stage for subsequent discussions amongst Heads of State. Notwithstanding, differences in culture and communication only added to market uncertainty. On the one hand, the French approach appeared to set the bar high, providing optimistic assessments on the outcome of upcoming meetings. In contrast, the Germans tended to be the polar opposite, managing expectations to the downside. More broadly, the differences in cultures and motives across Europe were epitomized when, after EU leaders painstakingly came to agreement on measures to address sovereign debt risks in October, then-Greek Prime Minister Papandreou announced a surprise referendum to vote on whether the Greek populace backed implementing the austerity measures that were just agreed on. Many in Europe took this as a slap in the face. After all, amongst the agreed upon measures was a 50% “haircut” to be applied to Greek government bonds and an additional injection of €130 billion into Greece. Not surprisingly, Merkozy told Papandreou, in no uncertain terms, that if he was to go ahead with the referendum, then the Greek populace would have to be asked whether Greece should remain part of the EU and the euro, and by the way, Greece would not receive any aid until the referendum results were finalized, as there was no certainty that Greece would still be a part of the EU. Not surprisingly, Papandreou backed down from the proposed referendum. Ultimately, though, he probably got what he wanted: to resign and leave the debacle behind him, but not before giving the markets a heart attack in the process.

The above example is indicative of the varying motivations that influence different factions within the EU (not to mention Italy’s Berlusconi, or the U.K.’s recent decision to veto proposed EU-wide fiscal changes). Moreover, it is not a Europe-specific trait, but a global one: look at the debt ceiling debacle as a prime example of the shambolic state the U.S. political system finds itself in. Indeed, that event prompted S&P to subsequently downgrade the credit rating of the U.S., citing politicians’ inability to come to an agreement when it was most needed, as a leading cause. This severely affected market optimism and confidence, further weakening the market’s trust in politicians. Compounding matters, Moody’s moved the U.S. credit outlook from “stable” to “negative” on the back of the “Super Committee” failing to come up with anything regarding a sustainable long-term fiscal outlook. Political bickering is nothing new, but it appears we have entered a period of increased polarization. Importantly, this dynamic is unlikely to abate over the foreseeable future. Unfortunately, it is likely to result in ongoing market confusion and enhanced levels of volatility into 2012.

Ongoing political uncertainty is likely to continue to weigh on markets. With ongoing financial tensions in Europe evolving into contagion risks to global economic growth, we believe central banks around the world may begin another round of expansionary monetary policies in 2012. The process is already underway – policy makers in Asia, notably China, have already begun relaxing policies, while the central banks of Australia, Norway, Sweden and the ECB have all cut target rates. There will be a much more dovish composition of FOMC voting members in 2012 and the central banks of Japan and the U.K. have also shown they are most willing to put in place expansionary policies. We believe these trends will benefit the currencies of commodity producing nations, as well as the Asian region.

In Europe, we are likely to witness a protracted process towards greater integration, but we must stress that it is unlikely to happen in a timely fashion. We have long argued that the process will be drawn-out and likely to be ugly at times. That’s because policy makers have differing motivations – namely reelection and thus, pandering to their respective constituencies – that muddies the political debate. The market simply needs to come to grips with this reality. Importantly, we don’t believe it is in any country’s interest to leave the Eurozone, either weak or strong. Former Greek Prime Minister Papandreou’s quick decision to cancel the referendum as soon as Greece’s euro membership came into question is a prime example. On the other side of the coin, Germany’s economy would be nowhere near as strong as it is today if it weren’t a part of the euro; Germany is effectively operating with an artificially weak Deutschemark, which has propelled its export-driven economy, and policy makers realize this. That said, we do believe that sovereign nations may eventually default, Greece being the primary candidate, but if the European financial system is adequately protected, the Eurozone may ultimately emerge from this crisis stronger.

Germany in particular, finds itself in a challenging situation. The Eurozone needs a clear leader, a country to steer the bloc in the right direction and implement tough decisions and fiscal austerity across nations, for the good of the whole. Germany is the natural choice for such a role, but given its history in Europe, the Germans still appear reticent to take up this mantle. They are in a tough position, not wanting to be seen as imposing their will on the European populace, yet understanding some form of fiscal discipline is sorely needed. This only compounds the problems faced in Europe and is likely to exacerbate the length of time to come to agreement on comprehensive reform.

Our view is that European politicians must focus on saving the financial industry – European banks – instead of overtly focusing on the sovereigns themselves. Unfortunately, political dynamics and realities make this very difficult. To protect their respective financial industries, the fiscal position of sovereigns must be compromised; politicians have to make the choice to essentially sacrifice their country’s credit ratings for the good of the whole. This is politically unpalatable, but in our view, an eventuality should the Eurozone survive. Politicians need to embrace this reality; the problem is that it could be a very messy road getting to that point. Furthermore, politicians are not known for taking proactive decisions, for the obvious reason that should the decision prove unpopular or disastrous, they lose their job. In this context, it is the bond market that has been forcing policymaker’s hands. It is only when spreads widen to such a level that funding costs threaten long-term fiscal sustainability, that politicians jump to action. Said another way: market volatility and stress is implicitly required for politicians to implement any substantive reform.

Global ramifications…

This dynamic has been seen in the Eurozone, but is lacking in the U.S. The bond markets haven’t forced Washington to implement any stringent austerity measures to date. It is likely that Europe continues to muddle through, putting in place piecemeal fixes, as markets force politicians into action. What is sorely needed is a defined process that clarifies how rescue funds are to be deployed, which may help mitigate the patchwork approach to addressing issues anytime a crisis flares up. Nonetheless, austerity measures have been put in place in Europe, and on this front; Europe is ahead of the curve relative to the U.S.

What is important to realize is that this is not a Europe-specific problem; it is a truly global one. We believe a key reason why central banks decided upon their coordinated action to provide dollar swap facilities (primarily aimed at thawing European dollar funding) was to alleviate global contagion fears. Indeed, after the announcement, Asian currencies exhibited some of the greatest strength. In our opinion, there is a very good reason for this. Asian countries may have the most at risk should the European banks decide to pare down their dollar exposures.

The coordinated action was aimed at putting a cap on the cost to access dollar funding via the swap market for European banks. These costs were approaching untenable levels. The Fed provided the ECB with cheaper access to dollar funding so that the ECB could, in turn, provide such funding to the European financial industry. The ECB also relaxed collateral requirements, making it cheaper to access such funding. European banks were demanding dollar liabilities (through the swap market, swapping euro payments for dollar payments). Why? To manage asset and liability risks. A bank aims to approximately match asset-liability risks, such as duration and currency exposures, such that market movements have little effect on the equity component of their capital structure. In this circumstance, European banks were demanding dollar liabilities to match dollar-denominated assets. The largest assets for a bank are typically loans; thus as the costs to access dollar liabilities increased, so too did the risk that European banks would simply pare down dollar-denominated loans.

So why did Asian economies benefit from the dollar swap announcement? In our view, it is because Asian businesses have accessed dollar denominated loans from European banks; the dollar-denominated assets sitting on European banks books are loans made to emerging market Asian economies, amongst others. Asian businesses’ reliance on European funding may have been magnified with restrictive policies put in place in the region. For instance, China had increased the reserve requirements for domestic banks and in some cases restricted lending altogether. Therefore, Asian economic growth may be at risk should European banks decide to pare down their dollar-denominated assets.

Faced with rising costs to access dollar liabilities, a bank has options: stomach and/or pass on the increased costs, raise more capital, or pare down dollar-denominated assets (de-leverage). With the coordinated announcement, the intent was to limit costs; concurrently, however, policies are incentivizing de-leveraging.

The inherent design of bank regulation carries much of the blame. National regulators typically consider their own government debt risk-free. In the U.S., Treasuries are risk-free by regulation. Similarly, European banks are incentivized to carry much of their capital in their respective sovereign debt, as those securities comply with capitalization rules. This has caused significant stress in the inter-bank lending market, where those banks perceived to have large exposures to risky sovereigns (e.g. Greece, Italy) are shunned. In Europe, where each Eurozone government regulates its own banking system, it’s urgently necessarily to centralize bank regulation, so that each member country’s bank is not ex-ante over-exposed to their own government paper. Naturally, the respective governments are opposed to such moves, as it may increase the cost of government funding, should banks have to evaluate the creditworthiness of their own governments.

Rather, banks appear to favor following a concerted effort to shrink outstanding loans to meet capital requirements. Indeed, PriceWaterhouseCoopers recently noted that European banks are expected to sell unprecedented levels of loan portfolios over the foreseeable future. Those same loans underpin ongoing business investment and expansion. Moreover, much of the dollar-denominated loans have been made to emerging economies in Asia and Eastern Europe; given that Asia has been the engine of global growth, there is a significant risk to the outlook for the global economy. This is why it is a truly global problem.

What the world needs is a change of oil, to keep the motor running smoothly; indeed, Chinese policy makers recently reversed the aforementioned restrictive policies, relaxing required reserve ratios for banks and even temporarily weakening the currency (albeit moderately). Chinese issuance of dim sum bonds in Hong Kong has exploded in recent times, and may be an additional source of funding that will take an evermore-important role in substituting European bank financing, should European banks continue to pare-down assets. Indeed, the three biggest underwriters of dim sum bonds – HSBC, Standard Chartered, and Deutsche Bank anticipate that issuance will double in 2012. Other Asian policy makers have followed step, implementing easier policies and in many cases, intervening to weaken their respective currencies. We believe this is the start of another period of easier monetary policy globally.

With ongoing European bank deleveraging acting as a headwind to global growth, central banks are likely to favor a more expansionary stance in 2012. We have already witnessed the central banks of Australia, Norway, Sweden and the ECB cut target rates. The ECB in particular has also offered two three-year long-term refinancing operations (LTROs), the first of which garnered demand from 523 banks for a total of €489.2 billion (approximately €193 billion in additional lending). We believe it is only time before the Fed, Bank of Japan and Bank of England get back on the horse and restart their printing presses. In the U.S., the composition of voting members of the FOMC is set to become much more dovish in 2012. The Bank of England has shown the willingness to expand the balance sheet even with inflation running around 5%, and the Bank of Japan has applied expansionary policies to the purchase of a broad range of asset classes, including listed REITs, ETFs and corporate debt. Should we enter another period of easy monetary policy, we believe the beneficiaries will be the economies of commodity-producing nations, and in turn result in strength of their respective currencies.

Asia matures…

In 2012, we will also witness one of the more significant leadership changes of recent years – we’re not talking about the U.S. Presidential election in November, but the transition of power in China. The Communist Party is set to appoint seven new members to the currently nine-member Politburo Standing Committee – China’s topmost leadership body. Xi Jinping and Li Keqiang are set to become the President and Premier of State, respectively, replacing Hu Jintao and Wen Jiabao. Given that China maintains centralized government control over much of the country, even a marginal change in leadership composition may have deep and far reaching implications for China and investors globally. We believe that current and expected initiatives, in concert with economic realities and political dynamics, are likely to lead to the adoption of more flexible market dynamics and ongoing gradual strengthening of the Chinese currency through 2012.

We consider China will increasingly focus on growing the domestic economy and middle class, while relying less on the export sector as a driver of economic growth. Moreover, Chinese politicians are likely to allow a gradual appreciation of the Chinese Renminbi, as a natural valve in addressing inflationary pressures. For an in-depth analysis of the implications of China’s leadership transition, please read our White Paper on the topic.

In the U.S., it is unlikely that long-term fiscal reform will be implemented ahead of the November election. That said, the debt-ceiling debacle and inability of the Super Committee to come to agreement has only frayed the confidence in Washington. Ultimately, we believe these dynamics serve to erode the safe haven status the U.S. dollar has held for so long, and combined with the Fed reopening the monetary floodgates, may underpin ongoing weakness in the U.S. dollar. We continue to see asymmetric risks to the outlook for U.S. Government paper. Should the market aggressively price-in the unsustainable fiscal situation, we may witness a substantial increase in yields. Such an event may precipitate government action similar to that seen in Europe. Unfortunately, the market is simply not applying the pressure on Washington, seemingly giving U.S. policy makers a pass. As such, there is little incentive to implement fiscal reform in the U.S. and thus the long-term situation is likely to deteriorate over the near term. On a relative basis, those countries that are putting measures in place to get their houses in order may appear more attractive investment propositions.

With so many dynamics set to unfold throughout 2012, we are excited by the potential investment opportunities, Specifically, we believe strategic value may be found outside of the U.S. dollar, in the Asian region and commodity producing nations.

Axel Merk

Manager of the Merk Hard, Asian and Absolute Currency Funds, www.merkfunds.com

The US Dollar Tries to Find Some Hope

green dollar sign

Last Friday, the Dollar Index cut its smallest daily range in almost four months as traders that stuck around for much of the week for the slight chance of a market collapse unwound into the extended holiday weekend. As with the S&P 500, the Dollar is looking to end this year little changed from where it began. However, the volatility that we have seen these past 12 months speaks to the bigger fundamental conflict behind the capital markets: the knowledge that yields and growth are deteriorating against the hope that stimulus will keep markets stable. This is a dangerous balance. It is evidenced by the exceptional swings and the surge in central bank balance sheets through the year. But can be viewed as a success if the alternative is full blown global economic crisis.

Heading into the new trading year, the headwinds of economic crisis may return to unsettle investors. Given the diminished influence of policy actions taken by the Fed and European Bank authority through the past year, it is reasonable to argue that skepticism and deleveraging are now the dominant trend. The QE programs, liquidity infusions, guarantees and other efforts have been the only thing holding back the rising tide of economic fire. With financial market’s building immunity to the temporary effects of intervention, these programs will have to be implemented more rapidly or come in greater size to maintain current levels of help. The problem officials have is that without a natural return to economic expansion and investment, the sheer weight of the market’s deleveraging could overwhelm the sizable but limited support that they can raise through quantitative easing.

For the Dollar, the constant threat of a market wide collapse in sentiment is promising. Just as the buck surged through Q4 of 2008 on a financial crisis that began in the United States, the currency may follow the same path with a Euro led spread that undermines its only practical substitute as a reserve currency. With that said, with each effort to put out the flames, the dollar may come under pressure. Even a period of stability curbs the need for an absolute liquidity currency with a small yield potential.

David Frank, Chief Analyst , Ava FX

DISCLOSURE & DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER.

Taps for the Dollar

green dollar sign

By Michael Pento, Senior Economist at Euro Pacific Capital

It now appears that the United States has finally succeeded in its efforts to destroy confidence in the U.S. dollar. Given the currency’s reserve status, its ubiquity in financial markets, and the economic power and political position of the United States, this was no easy task. However, to get the job done Washington chose the right man: Fed Chairman Ben Bernanke. Thanks to Bernanke’s herculean efforts, investors across the globe have now been fully weaned from their infantile belief that the U.S. dollar will remain the ultimate safe haven currency.

The proof of Ben’s success can be seen in comparing how the foreign exchange markets reacted to the recent crisis in the Middle East with how they reacted to the financial crisis of 2008. Back then, investors looking for safety abandoned their foreign currency positions and piled into the U.S. dollar (the market for U.S. Treasury Bonds in particular). As a result of these fund flows, the U.S. dollar surged 20% from August to November 2008.

However, during this latest round of global destabilization the dollar experienced no such rally. In fact, the greenback shed about 5% of its value since the Tunisia revolution began in December of 2010. The reason should be clear; the Fed has placed international investors on notice that it will unleash even greater doses of dollar debasement at the first whiff of additional economic weakness, deflation threat, or dollar appreciation. Just this week, Bernanke once again made clear that despite what he considers to be a better growth outlook at home and abroad, and spreading global inflation, the United States will not pull back from monetary accommodation, even as other nations conspicuously do so. The architect of U.S. monetary policy has stated explicitly that dollar debasement will continue for the indefinite future.

Knowing this, why would any international investor seeking a “safe haven” choose to park assets in U.S. sovereign debt? If Bernanke is to be believed, continued economic weakness in the U.S. will cause low-yielding Treasuries to lose value due to inflation while the weakening dollar erodes the underlying value of the bond in real terms. This is a one-two punch that sane investors will seek to avoid. It is no coincidence that a record percentage of U.S. Treasury auctions are now being bought by central banks, for whom sanity is a lowly consideration.

But in reality, the Fed has much less influence over the dollar’s value than do central bankers in Beijing. There is little disagreement among economists that without Chinese support, the dollar would be a dead duck. But for the last twenty years or so the monetary arrangement that pegged the yuan against the dollar served the interests of both countries. The U.S. enjoyed a flood of cheap imports, the benefits of ultra-low interest rates, and a strong currency. The Chinese received a booming export economy, which accounted for about a third of the country’s GDP, and the ownership of a significant portion of the future of the United States. To maintain this peg, the People’s Bank of China had to print trillions of yuan and perpetually hold more than $1 trillion U.S. dollars in reserve.

But recently, having led to rampant money supply growth and inflation in China, the peg has become more trouble than it’s worth, particularly from the Chinese perspective. The latest reading on YOY money supply growth has China’s M2 increasing by 17.2%; which has helped send their reported CPI up 4.9% YOY.

Inflation in China is pushing up the prices of its exports. According to the latest survey released February 14th from Global Sources (a primary facilitator of trade with Greater China), export prices of various China products are likely to increase in the months ahead, especially if the cost of major materials and components continues to soar. The survey of 232 Chinese exporters revealed that 74% of respondents said they boosted export prices in 2010. The U.S. Bureau of Labor Statistics reported in early January that its China import price index rose 0.9% in the fourth quarter after holding steady for the previous 18 months. And Guangdong, the biggest exporting province, said recently that it would increase minimum wages by around 19% this March.

But here is the rub; China maintains its peg in order to keep export prices from rising in dollar terms. But the peg is now causing export prices to rise anyway. As a result, the policy is a dead letter. The simple fact is that the threat to China’s exports will exist whether they let their currency appreciate or not. But a strong currency offers the benefit of greater domestic consumption, while a weaker currency offers nothing.

The Chinese government will take the path that preserves and balances their economy while enriching their entire population, rather than go down the road to never ending inflation. For China the realistic hope is that the greater purchasing power of a strong currency will enable their growing middle class to supplant U.S. consumers as the end market for China’s own manufacturing efforts. However, for the U.S. the challenge will be to develop a diversified manufacturing base in an expeditious manner before surging interest rates, a plummeting dollar and soaring inflation overwhelm the economy.

The dollar’s recent reaction to the turmoil in the Middle East and China’s inflation problem illustrate that we have come to a watershed moment in American history. The decade beginning in 2010 should prove to be the decade in which the U.S. dollar loses its status as the world’s reserve currency. As bad as that blow may be, the loss may provide the shock needed to get our economy back on a sustainable path. The real danger lies in refusing to adapt to the changing environment. Our current economic stewards are acting as if the dollar’s status is written in stone, when in fact it’s hanging by a thread.

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I’m No Dollar Permabull. I Just Go with the Facts!

green dollar sign

by Bryan Rich

Bryan Rich

I’ve given plenty of arguments in my Money and Markets columns over the past couple of years as to why I think the pontifications about the dollar’s demise are greatly exaggerated. The fact is, the dollar is still with us! And it’s been trending higher against a basket of most widely-traded currencies since the global crisis erupted.

Make no mistake: I’m not a permabull on the dollar. I simply side with the evidence. And on a relative basis, given the scale of global economic problems, the dollar is still a front runner in the least ugly contest.

Here are three reasons why …

Reason #1:
Money Is Moving Out
of Emerging Markets …

The wave of monetary policy tightening in the emerging market world is threatening a sharp slowdown in what has been a refuge of growth in the midst, and wake, of one of the worst global economic downturns on record.

With the writing on the wall, stocks in these markets have rolled over. Several have already visited double-digit loss territory for the year — including the likes of Chile, Indonesia and India.

And capital has moved away from these countries in favor of the developed markets — the precise opposite flow most experts were expecting for 2011. In fact, the weekly outflows in emerging market ETF’s hit record levels earlier this month.

With that, I think the dollar has the fuel to make its next leg higher. And I think it can go a lot further and extend a lot longer than many people expect. Especially when you factor in that the U.S. is expected to outgrow the UK, Japan and the euro zone this year by nearly 3 to 1.

Meanwhile market interest rates in the advanced economies have screamed higher in recent weeks, but the impact has not yet been felt in the dollar.

Reason #2:
The Dollar Is Losing Merit
as a Funding Currency …

Both the Swiss franc and the Japanese yen were the most widely-used funding currencies when the carry trade (i.e. borrowing low yielding currencies to fund the purchase of high yielding currencies) was at peak popularity.

This is because, while most global short-term interest rates were near or well above 5 percent in the late stages of the global credit boom, interest rates in Switzerland and Japan were still closer to zero. And that made it most appealing to borrow Swiss francs and yen to fund highly leveraged carry trades.

But with other developed-market interest rates scraping along the bottom in recent years, there have been other alternatives to fund carry trades — namely U.S. dollars.

Now that is changing …

As market interest rates have risen across the board in recent weeks, and as the bond markets have begun pricing in more risk and more inflation pressures, so has the appeal of higher market interest rates in the U.S. — like a 10-year Treasury sniffing toward 4 percent.

Consequently, we’re seeing the early stages of the “carry trade of old” return. And this dynamic has been most clearly expressed in the dollar/Swiss franc and dollar/Japanese yen exchange rates.

The dollar has broken eight-month downtrends against both the Swiss franc and the Japanese yen. And given the Swiss exposure to European sovereign debt crisis and Japan’s problematic fundamental outlook, this trend break for the dollar could prove the early stages of a long-term trend change.

Reason #3:
The Charts Confirm the Dollar
Is in a Good Spot to Buy

When we hear a report from mainstream media on how the dollar is faring, it’s typically a reference to the trading performance of the dollar index. While currencies are only valued on a relative basis, against the value of another currency, the index is a gauge of how the dollar stands against a basket of widely traded currencies — namely the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc.

You can see in the chart below that the cycles on the dollar index tend to last around 7 years on average. And based on this history, the cycles continue to argue the buck is less than half-way through a bullish cycle. To be sure, it’s been a choppy one.

But the dollar continues to trend higher, making higher lows along the way. And I think we can see a new high in this cycle this year. That’s 15 percent higher from current levels.

Long Term Dollar Cycles

For more perspective, the following weekly chart going back to the failure of the Bretton Woods system shows the historic bottoming formations in the dollar over the past 40 years.

This chart is designed to look back and see what happened to the dollar in the past when the chart pattern looked like it does now. You can see the slope of this current uptrend (in the green box) is consistent with prior bottoms, particularly the bottom in 1978 (the white box), which initiated a big bull cycle in the dollar.

Dollar Index Weekly

Finally, the next chart shows the last two, dollar cycles. You can see the key channel support for the dollar (the red channel), which presents an extremely attractive low risk/high reward place to buy dollars.

Dollar Index Weekly

So when you add it up all the evidence, despite its naysayers, and the avalanche of challenges surrounding its future, the dollar is looking more and more appealing to global investors.

Regards,

Bryan

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

What’s Your Dollar Really Worth?

green dollar sign

By Sean Hyman, editor, Currency Cross Trader

As you guys know, I’m a trader. I eat, sleep and breathe the $4 trillion Forex market on any given day.

But that’s just my day job.

The other half of my life is spent at home. I live in Texas. I’m married, I have four kids and I’m paid in U.S. dollars like 300 million or so other Americans.

That means my wife and I have to pay for our groceries, gas, kids’ school supplies, DVD rentals, etc. with dollars just like everyone else here in the U.S.

So like you, I have a vested interest when the U.S. dollar buys me less. In economic terms, that’s known as purchasing power.

Now as a trader, I can tell you the dollar has lost against nearly all major currencies in the Forex market since the late ‘90s. (See the sidebar below for more.)

But I’d like to step outside of the Forex world for just a moment and discuss just how the dollar has sunk beyond of the realm of currency trading, for all of you, who like me have to pay for your items with dollars…

1998 Dollars and 2011 Dollars Are NOT the Same Thing

Just to show you how weak the dollar is for consumers, let’s look at how many “extra dollars” it now takes to buy things nowadays.

To illustrate this, let’s review the common goods you would have purchased roughly 10 years ago (1998 actually).

Back in 1998…

How Currencies Have Jumped vs. the Dollar in the Forex Market

(From 1998 – Present Day)

Japanese yen: Up 57%
Aussie dollar: Up 51.9%
Swiss franc: Up 51.4%
Canadian dollar: Up 44%
New Zealand dollar: Up 31%
Norwegian krone: Up 26%
Euro: Up 22%
Swedish krona: Up 19%

An average house cost $129,000. Now it’s $172,000 (33% increase)…and that’s after the real estate market crashed.

A gallon of gas was $1.15 and now it’s almost three times that at $3.15 (actually 274% higher)!

A loaf of bread was $1.26. It’s now $2.79 (121% higher).

A dozen eggs cost 88 cents, now $2.89 (228% higher).

A postage stamp was 32 cents.
Fast forward to 2011, and its 44 cents (38% higher).

What can we thank for the higher prices?

Well, as strange as it sounds in this current post-recession, still deflationary environment, inflation stole your dollar’s value over the last decade.

Why Most Americans Don’t See the Dollar is Dropping

Inflation – especially over the years – is so subtle that most people don’t notice.

It’s a lot like boiling a lobster in a pot.

If you drop a lobster into boiling water, your lobster will try to escape. But if you drop a lobster into warm water, and slowly turn up the heat, lobsters won’t realize it and before they know it…they are boiling.

Guess who’s the lobster now? The American consumer.

The U.S. government and its close cousin, the Federal Reserve is pretty slick. They turn up the inflation heat by eroding your dollars slowly. But it’s consistent enough to where your dollar is worth much less just 10 short years later.

Think about it. If I’d told you that tomorrow morning you will pay 274% higher for gas and 121% higher for a loaf of bread…you would freak out. There would be rioting in the streets. (A lot like what’s happening in Tunisia today.)

Of course, the U.S. government knows that too.

So the Federal Reserve ratchets up inflation just fast enough to help their causes (like paying back their debts with cheaper dollars)…but they do it slow enough to where most Americans won’t notice.

The Dollar’s Purchasing Power Has Dropped 27% Since 1998

Now sure you can look at gas prices, and see inflation creeping back into the market. But the reality is the costs of EVERYTHING you need are going up astronomically and the dollars in your pocket buy less and less all the time.

What’s even worse is that while the costs of goods are on the rise again…unemployment is hitting its highest levels in 26 years. So that means that companies won’t raise salaries to keep up with the ever-rising cost of living.

And unfortunately prices are only going higher from here. In fact, in the next decade, prices could be another 50-100% higher than they are now.

Three Ways to Protect You and Your
Family Against the Falling Dollar

You don’t have to be a Forex trader to be affected by the falling dollar. No, just make a trip to the grocery store or try to fill up your tank, and you also have a vested interest in how the dollar performs.

Now of course, none of us can stop inflation. But there is a way to hedge against it, and the falling dollar. Here are a few ideas how…

• Diversify at least 15% of your portfolio into stronger foreign currencies including the Canadian dollar and Aussie dollar. You can do this easily with currency ETFs if you’re not ready to jump into FX trading.• Calculate how much you have to spend on stocks and bonds for the next year, and then drop 5-10% of that into gold or silver. Again, you can easily do this with gold or silver ETFs.

• Look at your retirement plan. If your entire IRA is in dollars, consider upgrading with a long-term foreign currency CD.

Bottom line: The dollar is losing on all counts. As a trader, I can see the dollar’s overall decline happening on a day-to-day basis. But as a consumer, you can feel the dollar dropping where it really hurts – your wallet. Take action now to protect yourself.

Thanks for reading!
Sean Hyman, Editor Currency Cross Trader
Blog: http://wcw.worldcurrencywatch.com/