Tag Archives: US Dollar

What Exotic Currencies are Saying about the US Dollar

One of the most confounding mysteries currently confronting the forex market is the dramatic drop of the US dollar. Few recent trends have continued for as long, or proved as lucrative, as the enduring fall of the currency since a new low was first reported on in summer 2014.

Forex brokers and traders watched, cautiously, as the EURUSD pairing broke the 2010 low, threatening to hit levels not seen since 2005 at 1.1640. Simultaneously, USDJPY’s 2007 high began to draw attention at the next upside target, at 124.41.

Despite this move higher, traders have remained unwilling to trust in the recovery of the currency, which has not been supported by a firm multi-percentage correlation. As a result, more and more of them are turning to foreign currencies in search of clues as to the future of the US dollar.

The Significance of Exotic Currencies

Although there is a tendency within the forex market to overlook them, exotic currency trends can provide a useful tool in the determination of the true state of the US dollar, helping to uncover whether it’s favoured across the board or only against low-yielding FX.

At the current time, a depressed interest rate environment largely defines the world economy. With interest rates having been lowered around the globe in line with the aims of quantitative easing programs, an assessment of the performance of individual currencies can be distorted. This is where exotic currencies come in useful, as the economies whose interest rates have remained high provide a unique look into the performance of the low-yielding US dollar.

For those with an understanding of the bond market, parallels can be drawn between the role of these exotic currencies and the section of the junk bond faction. The junk bond faction is made up of companies with lower credit ratings than the blue chips that most people are familiar with. The performance information they provide is unique, and can be used to provide a more coherent picture of the market in terms of rebounds in risk and fluctuations in risk sentiment before they become obvious through comparisons with other sections. Similarly, exotic currencies provide a unique insight into the position of the US dollar, and could thus provide an early opportunity to cash in on this.

Recent Events

The US dollar’s recent gain is largely attributable to an announcement made by the Federal Reserve, which claimed that the country was ending its multi-year quantitative easing program. With many other central banks not yet embarked upon or in the midst of their own programs, this saw the dollar gain against low-yielding currencies like the EUR, JPY, CFH and GBP.

This trend was all that certain factions of the market took note of. However, by widening the lens, we see that higher yielding currencies, such as the ZAR, did not respond in the same way.

A second statement by the Federal Reserve, a commitment to ‘patiently’ raise rates over the course of 2015, has also been instrumental in fuelling USD fever. Yet if we look to the story told by exotic currency rates, the tale is very different A Bearish Engulfing Pattern is evident for the USDMXN pair, suggesting that something could be amiss. Indeed, a break below the 17th December figure of 14.37 could catalyse a drop against other higher-yielding currencies such as the AUD, NZD and ZAR, amongst others.

So what does this mean for the forex market and the position of the USD going forwards? With high-yielding currencies showing strength against the former currency, a charge against it could well be in the offing. Indeed, should certain levels fail to provide continued support, a real correction may be on the horizon.

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,


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

As China goes, so goes oil; as oil goes, up goes the U.S. dollar!

by Jack Crooks
Saturday, September 1, 2012 at 7:30am

Jack Crooks

I realize it’s never easy and rarely simple. But today I’m going to help you understand why global money-flow drives key markets and how that flow could be reversing. If I am right, it is good news for long-term dollar bulls like me, bad news for China bulls, and terrible news if you are still riding on the Peak Oil bandwagon expecting oil to hit $200 barrel soon.

Three major realities lead me to those conclusions:

Reality #1—
Foreign exchange reserves and
growth is falling in China

Some experts estimate that up to $50 billion a month is exiting China. Keep in mind, when money leaves China, it leaves as dollars for the most part. Investors exchange yuan for dollars inside China, or Hong Kong, then move those dollars to safe haven areas, such as U.S. Treasuries, U.S. farmland, or Vancouver apartment buildings.

Year-on-year change in Chinese
Foreign Exchange Reserves Growth

Chinese foreign exchange reserves

Reality #2—
Demand for oil is falling along with
global growth, and the U.S. is leading the way

China’s crude oil imports fell 3 percent in July from a month ago to a nine-month low.

The slowdown in growth is hitting oil demand hard in the country that has driven the increase in global fuel consumption for a decade. In fact, the International Energy Agency slashed its forecast for Chinese oil demand growth in 2012 by a third to 240,000 barrels per day (bpd) in its August monthly report. Just a month earlier, the agency had forecast growth of 360,000 bpd.

And in the U.S., according to Reuters, oil demand in July fell to its lowest level in nearly four years.

If demand is already low and appears to be heading lower, I think it is time to mark down oil prices.

The chart below shows oil hit a brick wall of resistance at around $98 per barrel; that happens to be a key retracement level. Plus, the price oscillators are turning down from an “overbought” level. This price action seems to be confirming bearish fundamental news.

Oil Futures Daily

Reality #3—
The dollar is the
world’s monetary standard

The demand for dollars is poised to rise as the supply falls. I say that because:

  • Dollar-based funding (supply) for trade finance and other credit lines is falling as European banks reduce the percentage of debt on their balance sheets.
  • As I explained above, dollars are leaving China. And I expect China’s foreign exchange reserve hoard to continue to decline.
  • Falling oil prices are dollar bullish, as countries that buy oil on world markets — priced in dollars — can reduce their dollar credit lines, which reduces the potential of a new supply of dollars from coming on the market.
  • If a global credit crunch similar to the credit crunch of 2007 materializes, demand for dollars and dollar-safe havens will soar.

Now, take a look at the chart below, which shows how all of these global money-flow factors discussed above relate to each other.

Chinese foreign exchange reserve growth (red line);
oil prices (black line); and the U.S. dollar index (blue line)

US dollar, oil, China FX

As you can see …

There is a lagging correlation between Chinese FX reserve growth and oil prices, with Chinese FX growth leading.

There is a tight negative correlation between oil prices and the dollar i.e. as oil prices rise the dollar tends to fall and vice versa.

If these macro trends continue to play out as I expect, your decision is easy: Sell oil, buy the dollar, and hold those positions until the trend changes.

Have a safe and happy Labor Day weekend,


Source: http://www.moneyandmarkets.com

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


Start Building Your “Anti-Dollar” Retirement Plan With These Extremely Undervalued Currencies

Evaldo Albuquerque, Editor, Exotic FX Alert

Two months ago, I told Currency Capitalist subscribers how Asian currencies were the new safe-haven currencies.

At that time, the Asian Dollar index, which measures the performance of emerging Asian currencies against the U.S. dollar, was hitting a new all-time high. That was right in the middle of the summer market turmoil.

In fact, Asian currencies were performing so well, that it appeared they would remain immune to the current woes in the U.S. and Europe. As one of the most fiscally sound regions in the world, it seemed Asia would continue to attract capital and push Asian currencies higher.

But just in the past 30 days, everything has changed…

That earlier resilience is gone. Most Asian currencies have been hit hard.

But that just creates a better buying opportunity for these currencies – especially if you’re buying for the long-term. Let me explain…

Asian Currencies Sell-Off Has Nothing
To Do With Asia

The fundamental story of Asian currencies has not changed in any way. What’s happening with these fundamentally sound currencies have little to do with what’s going on in Asia.

It’s all about Europe.

We’re seeing a sharp sell-off in Asian currencies because investors now fear Europe’s debt problems will hurt the entire global economy.

In other words, we’re starting so see contagion of the European crisis to the strongest part of the global economy. Investors are running for cover.

As the bellwether for Asian currencies, the Korean won provides a good example. It’s down 6% so far this month. That’s a big move for currencies.

And Asian Central Banks are not intervening to smooth the movements. Maybe they’re welcoming weaker currencies to boost exports in a world of slower growth.

The Singapore dollar, one of Asia’s strongest currencies, provides another good example. Let’s take a look.

When the Singapore Dollar is Weak,
You Know Something Is Wrong

The Singapore dollar is without a question one of the strongest currencies in the world in terms of fundamentals. So when it’s selling off, you know something major is going on.

You can see the daily chart of the pair USD/SGD (U.S dollar/Singapore dollar) below.

When it moves down, it indicates one U.S. dollar is buying fewer Singapore dollars. In other words, the Singapore dollar is getting stronger. And when it moves up, it’s getting weaker.

The pair just had a major spike higher, crossing above its 200-day moving average (blue line). It has also violated the downtrend line (black line).

These are the first signs the short-term trend is turning bullish for the dollar against the Singapore dollar.

More importantly, this is a sign things are getting really bad out there. The last time the pair USD/SGD significantly crossed above its 200-day moving average was during the 2008 crisis, as you can see in the chart.

U.S. Dollar Had Been Rallying Even Against the
Powerful Singapore Dollar

How to Buy Five Asian Currencies
for Your IRA

As I said, not much has changed in Asia. It remains a region where most countries have much lower levels of debt than developed nations. Asia is where you will still find the major sources of global economic growth in the years to come.

In the long-term, Asian currencies will continue to strengthen against the dollar. That’s why you should use these big dollar rallies to accumulate more Asian currencies, such as the Singapore dollar, on the cheap.

In short, Asian currencies remain the place to park your cash for the 21st century. That’s especially the case if you’re buying for your long-term retirement plan.

If you’re looking for an easy way to upgrade your retirement plan with Asian currencies, you might consider the Asian Currency Portfolio at the U.S.-based bank, EverBank.

This portfolio contains five Asian currencies for a $10,000 minimum investment. And you can invest in it with an Individual Retirement Account (IRA).

You should know that The Sovereign Society is an advertiser of EverBank, so we may receive fees if you choose to invest in their products. However, this Asian Currency Portfolio is worth mentioning regardless because it is one of the easiest ways to invest in Asian currencies here in the U.S

But again, that’s for the long-term. In the short-term, defensive plays will still prevail.

That means the dollar can continue to rally against those currencies. But you can also profit from that by buying the dollar through short-term trades in the spot Forex market.

But looking at the big picture, you should use those rallies to buy strong currencies, such as the Singapore dollar and Korean won, on the cheap. And hold them for the long-term.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert