What’s happening to the dollar? That’s the question dominating the world’s
financial markets. Last week the US currency fell, on a trade-weighted
basis, to a fresh 14-month low. The dollar’s decline is now gaining momentum.

By Liam Halligan

Published: 7:22PM BST 10 Oct 2009

Many American economists say the greenback is falling because the global
economy is recovering – so investors no longer need the dollar as a “safe
haven”.

That’s nonsense. The reality is that “safe haven” status has shifted
away from the dollar and towards tangible assets that the US government
can’t debauch by printing more of them. That’s why gold just hit a fresh all-time high of well over $1,000 per ounce.
That’s why commodity-backed currencies like the Australian dollar are now
soaring – causing howls of protest from Aussie exporters. Meanwhile, global
investors are quitting the US currency because they’re worried it’s a
sinking ship.

It’s hard to disagree. America is still running a current account deficit
equal to almost 3pc of national income. In a single month over the summer,
the gap between America’s imports and exports widened no less than 16pc.

America’s external imbalance remains sizeable in part because the country is
the world’s biggest oil importer. When crude prices rise, Uncle Sam’s trade
deficit increases, which, in turn, pushes down on the dollar.

As every financial analyst knows, a falling dollar means rising oil as the
black stuff is priced in US currency. But the relationship also operates in
reverse. When oil strengthens, the dollar tends to weaken as America’s trade
deficit suffers. Crude is now more than 50pc above its mid-February low –
ergo, a weaker dollar.

The dollar is also falling because that’s what the White House wants. “It’s
important America continues to have a strong currency,” said US
Treasury Secretary Timothy Geithner last week. “We’ve made clear our
commitment to a strong dollar,” added Larry Summers, the Head of
President Obama’s National Economic Council.

These men insult our intelligence. The US government desperately wants a
weaker dollar – so boosting exports while lowering the value of America’s
massive foreign debt. The currency markets will keep betting against the
greenback as they know the Federal Reserve will do nothing to stop a weaker
dollar coming true. “Benign currency neglect” is the cornerstone
of Obama’s recovery strategy.

The danger is, though, that “the rope slips” and steady decline
turns into nosedive. If the dollar did tip into free fall, US inflation
would soar and interest rates would skyrocket – whatever the Fed now says.
The world’s largest economy would then face “stagflation” – the
nightmare combination of recession and high inflation.

This danger is very real, not least because the rest of the world is seriously
concerned at America’s wildly expansionary fiscal and monetary policy.
That’s the fundamental reason the dollar is falling.

Just over a year ago, America’s monetary base was equal to 6pc of national
income. Now, after a year of money printing, it’s 12pc. The US has expanded
its basic money supply by a staggering 108pc in 12 months. No wonder the
currency markets are alarmed about future US inflation. No wonder there is a
widespread assumption so-called “quantitative easing” – or QE –
will continue, funding yet more bank bailouts and other forms of wasteful
government spending.

On top of all this, we must now add “carry trade” pressures. As this
column pointed out last month, investors are using low Fed rates to take out
inexpensive dollar loans, then converting the money into higher-yielding
currencies. “Carrying” credit in this way is flooding the world
with cheap dollars – pushing the greenback down even more.

There are broader reasons for the dollar’s demise – not least that the sun is
now setting on its reserve currency status, as the world’s commercial centre
of gravity shifts towards the emerging giants of the East. That’s a much
longer-term trend, though. In the here and now, the dollar is tumbling due
to America’s ultra-low interest rates, monetary incontinence and fiscal
irresponsibility.

The decline became so steep last week that central banks in Asia – including
China – spent their own reserves propping up the US currency, so worried
were they about the impact of the falling dollar on their all-important
exports. Future historians will shake their heads in disbelief.

Keep in mind, though, that the arguments pointing to a weaker dollar also
apply to the pound – but even more so. Last week sterling hit a
trade-weighted five-month low. Over the last year, the pound has, well, been
pounded – losing significant ground against the yen and euro, as well as the
ailing dollar.

Like the US, Britain has indulged in grotesque money-printing antics. The two
countries might be dubbed the QE2. But the Bank of England’s printing
presses really have been in overdrive, with the UK’s monetary base now equal
to almost a fifth of GDP, up a head-spinning 169pc in a single year.

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The Daily Reckoning

“It was at Rome, on the 15th of October, 1764, as I sat musing amidst the ruins of the Capitol, while the barefooted friars were singing vespers in the Temple of Jupiter, that the idea of writing the decline and fall of the city first started to my mind.”
– Edward Gibbon

Warren Buffett famously says that people do not make money by betting against the US economy. But two years ago we decided to take a chance.

“We are short the United States of America,” we announced from the comfort and safety of our headquarters in London. “Sell its stocks. Sell its bonds. Sell its money. Sell its real estate. Sell the equity. Sell the debt. Sell everything.”

What we saw was an over-stretched empire getting ready to snap. But we were also allowing ourselves to be lazy. Rather than deconstruct the capital structure of the world’s largest economy, we decided to sell the whole damned thing.

All Hell broke loose in September 2008. Since then, US stocks have gone down about a third. Real estate too. Unemployment has doubled. Consumer prices are going down at the fastest rate since the ’50s. And the economy is in the worse recession since WWII.

Meanwhile, Americans’ per capita wealth has fallen from $172,000 in September from $212,000 two years earlier. And the UN reports that the quality of life in America has gone down too…from #5 on its list in 2000, it fell to #13 in 2007. No doubt it is below #20 now.

Buffett has lost billions betting on the US economy while our gold positions are handily up; gold was the most profitable major asset over the last ten years.

So you see, we were right; America was a sell two years ago.

And now it is the dollar that is falling. It’s gone down 12% in the last six months – a huge move for a major currency.

“Asia tries to slow dollar fall,” is the lead story in today’s Financial Times.

Today, a buck and forty-seven cents will buy you only 1 euro. Ten years ago, you could have gotten a euro for less than a single dollar. A falling dollar makes imports more expensive, say analysts…raising the cost of living in the homeland. But you wouldn’t know it from walking around on the streets of Miami or Las Vegas. You can get a house at 50% off its price three years ago. As for the breakfast special – for less than 3 euros you can get enough food to kill a Pakistani.

By European standards, America is cheap.

“Europeans again interested in Florida houses,” says a headline in The New York Times.

House prices are down 30% to 50%. The dollar is down about a third too. That makes the United States a bargain.

But is the United States of America about to become even cheaper?

One thing we were wrong about when we issued our ‘sell America’ call two years ago was US debt. Treasury bonds have resisted the general downward trend of things with the stars and stripes on them. Bonds have not gone down; they’ve gone up.

Private households are buying them for their retirements. Banks are buying them for risk-free profits. Speculators are buying them in anticipation of deflation.

David Rosenberg:

“The big story yesterday was the further massive $12 billion decline in outstanding consumer debt in August – the consensus was looking for an $8 billion contraction. This was the seventh month of debt retrenchment in a row. In other words, the tidal wave of the credit collapse continues unabated, and this is the primary reason why bond yields are still in a fundamental downtrend.

“Over the past year, consumers have run down their debt by a record $113 billion (and this does not include mortgages). This is an absolutely epic shift in household attitudes towards credit and discretionary spending.”

Americans are saving. And they’re buying US Treasury bonds. (More below…) But how safe is their money? Is it a good idea to buy US debt now?

On Wednesday, Latvia tried to raise a trivial amount of money. It offered $17 million worth of 6-month bonds. How likely is it that Latvia will default before Easter? We don’t know, but investors judged it not worth the risk. Not only did the bond auction failed, it failed with no bids.

That’s what happens when lenders lose faith in a government. They refuse to lend it money – except at high rates of interest. But the high rates of interest work like a noose on the neck of a cattle rustler. They block the vital flow of oxygen – not to mention breaking his neck.

Note that the US federal government is still functioning like an empire at the peak of its power. The Pentagon is still rustling up trouble all over the world – at a cost of trillions. US government employees are growing more numerous and richer – with twice the annual incomes of the private sector. And the Obama Administration – apparently unaware that the total unfunded debts and obligations of the federal government have soared to nearly $120 trillion – is considering new ways to get rid of cash.

Remarkably, investors still lend the US government money – asking only 4% annual yield on a 30-year loan. As for 91-day money, they practically give that to the feds for free; it sports only a yield of 0.066%.

This will surely be a point of puzzlement for the financial historian of the next century. It is certainly a point of puzzlement for us.

Yesterday, gold hit a new record at $1057. Doesn’t gold go up when inflation rates rise? And don’t bonds go down when inflation goes up?

So why are people buying bonds with such puny yields?

There is a lot of whispering in this market. Gold is trying to tell us something. Bonds are trying to tell us something. The dollar seems to have something on its mind too. Stocks are just babbling.

If gold is trying to signal that inflation is coming, the bond market is not paying attention. Bonds seem to be saying that it is deflation we should be worried about; but the stock market doesn’t seem to hear.

And there’s the dollar. The greenback is in the same choir with stocks and gold, as near as we can tell. They all seem to be chanting about inflation coming back.

But what if they’re all wrong?

Just look at what is going on in Washington, if you can bear it.

The feds have a budget that anticipates inflation and growth. Spending is supposed to remain flat until 2013. Tax receipts, which are no higher today than they were 10 years ago, are supposed to rise, gradually filling in the Grand Canyon of deficits. The number crunchers think we’re headed back to the Reagan years – when the tough-love policies of the Volcker Fed squeezed out inflation and created a real boom. Then, tax revenues rose 9% per year between 1984 and 1989.

How likely is that today? Not very. Instead, what is likely to unfold is a deflation story. Instead of staying flat, federal expenses are likely to rise as one failed stimulus gives way to another failed stimulus. Then, instead of going up, tax revenues will go down…digging an even grander canyon between out-go and income.

Then, or long before, there will be a panic out of bonds, the dollar, stocks – practically everything. Everything goes down!

At this point, the US will be in about the same situation as the Roman Empire as it approached retirement. Expenses kept rising. Rome had to pay the Blackwater-type military contractors of the era…in addition to keeping Roman mobs supplied with food stamps and unemployment benefits…while its tax base fell. Gradually, the empire lost the ability to defend itself.

When Edward Gibbon began his history of Rome’s decline and fall, Roman real estate had probably been in a bear market for at least 1300 years. Rome’s population fell from over a million to under 20,000. Politically, Italy had broken apart more than 1,000 years before Gibbon was born, and it wouldn’t be put back together again until nearly 100 years after he was dead.

It’s far too early to write the story of America’s decline and fall. That job will fall to some future historian, perhaps seated on the ruins of the Lincoln Memorial, wondering how people made such a mess of things.

Our guess is that he will come to the same conclusion we have: Stocks? Bonds? The dollar? Investors should have sold them all!

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a “uniquely refreshing” perspective on the global economy, investing, and today’s markets. Follow the Daily Reckoning on Twitter.

A Deflation Story

More articles from The Daily Reckoning….

Four numismatic news or coin blog articles are referenced on CoinNews every Tuesday and Thursday. These articles are not authored by us, but we recommend coin collectors read them for their unusual or interesting content. Here are today’s coin articles:

Of gold coin craziness and conspiracy
Tracy Alloway | Financial Times

In another instance of economics in reverse, the US Mint has suspended production of certain gold and silver coins … We note that in general, the craziness surrounding gold coins is just getting, well, crazier. To wit, the US Government bringing in the Secret Service to actively pursue 76-year-old gold coins …

Go to story »   

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Read the rest of Coin News: Gold Coin Craziness, Coin Collecting Hobby, 2009 Copper Cents (369 words)

The Daily Reckoning

On one hand, the deflationists are claiming that given the extremely high debt levels in the West, further inflation is impossible. On the other side of the argument, many proponents of inflation are calling for Zimbabwe style hyperinflation. In this business, everyone is entitled to their opinion; however it is my contention that we will get neither deflation nor hyperinflation. If my assessment is correct, once business activity picks up, our world will have to deal with high inflation.

Although I have great sympathy for the deflation crowd, given the reckless attitude of the central bankers and their ability to create debt-based money, I do not believe deflation (contraction in the supply of money and total debt) is very likely.

For sure, in this post-bubble environment, American consumer debt continues to contract, but this is being more than offset by the expansion in federal debt. Over the past year alone, federal debt in America has surged from US$9.645 trillion to US$11.813 trillion. In other words, during the past twelve months, American federal debt has risen by a shocking 24.47% and it now stands at 83.52% of GDP! Now, given the ability of the American establishment to essentially create dollars out of thin air, I have no doubt in my mind that it be able to inflate the economy. However, this will come at a huge cost and the victim will be the American currency.

In fact, the recent weakness in the US dollar is a sign that central-bank sponsored inflation has started to dominate the private-sector debt contraction in the West. Furthermore, over the past few weeks, various governments have issued US dollar-denominated debt and this suggests that the carry-trade is back in vogue. In a startling move, Germany recently announced that it plans to borrow money in US dollars!

Now, given the ongoing federal debt inflation, debasement of paper currencies, sky-high budget deficits and competitive currency devaluations, the macro-economic environment has never been better for precious metals. Yet, both gold and silver continue to frustrate the bulls by staying below the record-highs recorded in spring 2008.

So, what is going on here? Have we already seen the end of the precious metals bull-market or are we about to witness an explosive rally? Before I attempt to answer this question, I want to make it clear that even though gold failed to better its all-time high during last autumn’s panic, it was the only asset, (apart from US Treasuries) which stayed relatively firm. And looking at the various markets today, gold is the only asset that is flirting with its all-time high. So, whether you like it or not, gold deserves some credit for fulfilling its role as a safe haven.

Now, unlike some of the die-hard gold bugs, I don’t believe that gold is the ultimate asset to own at all times. Without a doubt, there have been times in history when gold has proven to be a lousy investment. For instance, between 1980 and 2001, the nominal price of the yellow metal fell by an astonishing 70%. This horrible price action spawned an entire generation who grew up hating gold and up until a few years ago, the vast majority considered gold a barbaric relic.

However, during other periods in history, when macro-economic uncertainty was high and inflationary expectations were running out of control, gold turned out to be a fantastic asset to own.

If my take on the macro-economic situation is valid, then we are in such a period now and gold must form a part of every investment portfolio.

You may remember that over the past year, central banks have injected trillions of dollars into the banking system and it is only a matter of time before inflationary expectations start spiraling out of control. Up until now, this ‘stimulus’ money hasn’t permeated through the economy in the West but once money velocity picks up, prices will start rising and the investment community will become very concerned about inflation. When the deflation scare abates and people start protecting the purchasing power of their savings, capital will start to flow towards precious metals.

Long-term clients and subscribers will recall that about two years ago, I highlighted gold’s tendency to rocket higher every other year. Figure 1 captures this trend perfectly and you can see that since the outset, gold’s bull-market has been punctuated by lengthy consolidations and the yellow metal has surged to a new high every alternate year.

Figure 1: Is gold about to shine?

So, if gold remains in a bull-market and its trend consistency is intact, its price should surge over the following months. Conversely, if the price of gold fails to climb above its all-time high before year-end, it should start to ring alarm bells as this would open up the possibility that the bull-market may be over. Remember, certainty does not exist in the investment world and savvy investors should remain open to all outcomes.

Now, given the uncertainty in the world today and the ticking inflationary time-bomb, my view is that gold will soon embark on its north-bound journey. So, I suggest that investors hold on to gold and the related mining companies which will probably continue to perform well until next spring.

As far as silver is concerned, it has always been a high-beta play on the direction of gold. If the next up leg in gold’s bull-market materialises, the price of silver will also head towards the heavens. Accordingly, investors may also want to allocate a portion of their investment portfolio to silver bullion and silver producing companies.

Regards,

Puru Saxena
for The Daily Reckoning

This article originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a “uniquely refreshing” perspective on the global economy, investing, and today’s markets. Follow the Daily Reckoning on Twitter.

Inflation is Our Future

More articles from The Daily Reckoning….

The US government printed less money for the third consecutive month, according to the agency responsible for manufacturing US currency.

Bureau of Engraving and Printing (BEP) figures released Wednesday shows that the government produced fewer total notes in August than in July.

The BEP again exclusively printed $1s, $20s and $100s. Added together, 435,200,000 banknotes were manufactured during the month. The total dollar value of those notes, however, was slightly higher with additional $20s making up the difference. August came in at $16,345,600,000 versus the $16.3 billion in July.

Spread across the 31 days in August, the BEP averaged 14 million notes per day with a total daily value of about $527.3 million.

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Read the rest of US Government Prints Less Money in August (263 words)

Bullion Vault

As the US fights deflation, credit inflation is alive and well in China…

The INVESTMENT COMMUNITY is divided at present as to whether the world economy faces hyperinflation or deflation, writes Puru Saxena of Money Matters and Puru Saxena Limited in Hong Kong.

Some observers are convinced that the central banks’ printing press will take the world towards hyperinflation whereas others believe that the ongoing contraction in American private-sector debt will result in outright deflation.

But what will the future bring? It is my contention that we will get neither hyperinflation nor deflation.

What is more likely is that, over the coming months, we will get another deflationary scare. Any sell-off in the markets later this year will be met by an even larger stimulus from the policymakers and this will ultimately result in high inflation.

So I maintain my view that due to the unprecedented policy responses around the globe, the world’s economy will face high inflation over the medium to long-term. And the general price level will double over the coming decade.

In the near-term however, we will probably get another period when the market will (once again) become concerned about the prospects of a lengthy economic contraction. It is conceivable that the ‘green shoots’ hype currently doing the rounds will soon be replaced by more economic worries as a second wave of foreclosures hits America later this year.

It is therefore possible that before year-end we will witness large corrections in stocks and commodities. Conversely, we are likely to see big rallies in US government bonds, the US Dollar and Japanese Yen.

Read more….

The U.S. government in February produced more banknotes for the second consecutive month, according to Bureau of Engraving and Printing (BEP) figures released Friday, March 13.

The agency in February printed more $1s, $20s and $100s and the same amount of $10s and $50s as January. No $5s were produced in either month.

In total, 556,800,000 banknotes were produced last month valued at $25,286,400,000. In contrast, the BEP printed 489.6 M notes worth $20.3 billion in January.

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Read the rest of US Government Prints 556.8 Million Notes Worth $25.3 Billion – Feb (380 words)