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THE US DOLLAR:
CURRENCY CRISIS FLEAS ON THE INFLATIONARY DOG
Many times recently I
have mentioned the amazing levitating US Dollar. By all usual
measures of currency strength, it should have broken long ago.
Presently the US Dollar holds the key to financial markets
world-wide. As long as the dollar remains high, things will hold
together; when the dollar cracks, other markets will crack with it.
While Greenspan and the
US Treasury are managing the dollar like a banana republic currency,
two things are saving them and the dollar. First, nations
world-wide hold dollars as their currency reserves, so the US can
export its inflation and the foreigners still have to hold dollars.
(What are they going to do, start a run on the dollar when they hold
billions of them already as reserves?) Second, foreigners have been
willing to invest in the US financial markets. Both of these forces
have kept demand for the dollar high.
Finally, the high dollar
has acted exactly like a payoff to countries mired in recession. A
high dollar mimics a world-wide high import tariff on US made
products, offering a bribe to countries that want to export to the
US. The high dollar makes their prices so low that they can easily
sell their products in the US; it also makes US products so
expensive that US manufacturers can’t export back to them.
Ahh, but when you lie
down the inflationary dog, sooner or later you get up with
currency-crisis fleas.
CLUES TO WATCH: FOREIGN
TREASURY HOLDINGS
In our interview in the
June ’01 Moneychanger,. Dr. Walker Todd stressed the importance of
foreign holdings of
US treasury securities. “Any significant liquidation of the foreign
position in US government debt would be a major danger signal” for
the US dollar.
Unhappily, tracking
these holdings is difficult, because they never report them in
National Enquirer or the Wall Street Journal. That leaves most of
us out in the dark. Here is a website where you can find the
percentage of US treasury securities held by foreign nations:
www.ustreas.gov/domfin/foreign.htm. Unfortunately, this is
yearly data. At end-1999, estimated foreign total was 39.2%;
end-2000, 41.7%; end November 2001, 42.8%. At least those numbers
give you an idea of the magnitude of foreign ownership of US
government debt. That magnitude also implies foreigners can really
hurt the dollar if they start selling those bonds.
However, it is much
easier to track the amount of foreign owned US government securities
held by the Fed. That appears in the Federal Reserve H.4.1 release
at
www.federalreserve.gov/releases/h41. When I reported in
December 2001, Fed holdings of foreign-owned Treasury securities
amounted to $732 billion; on 3/27/02, the last report, they stood at
$740.7 billion.
What does that mean?
That foreigners’ appetite for US Treasury securities remains
famished. Remember that with an approximately $400 billion per year
balance of payments deficit, foreigners must loan to the US (one way
or the other) over a billion dollars a day.
When they stop doing
that, the US dollar will land in huge trouble.
That’s why we need to
watch that number (Fed holdings of foreign-owned Treasuries), as
well as the course of the US Dollar Index, now trying to drop.
SECOND CLUE: THE DOLLAR
INDEX
The US Dollar Index is a
trade-weighted basket of currencies. (You wonder why they don’t
call it a “tub” of currencies, don’t you? A barrel? A clot? A
cauldron? Economists just have no imagination.) Instead of having
to look at the US dollar’s exchange rate versus a dozen different
currencies, you can merely look at the US Dollar Index that sums up
the exchange rates for a whole flock.
Right now the Dollar
Index is hovering above the crucial 117 level. However, it stands
well beneath its 50 day moving average (about 118.5). Cracking that
117, it will likely drop much further, at least to 115.
However, the longer term
chart shows something more important. Two tops appear on the dollar
index chart. The Index closed above 120 in July, and then crashed
into October when it ducked under 112. From there it climbed back
up to top barely over 120 at the end of January, then attempted but
fell short once more in late February.
This is not hopeful
action. The Dollar Index has been capped with a double top, which
makes a move above 120 most unlikely. Remember that since 1971 the
overall trend of the US Dollar has been down. The strength we have
seen the past five years – Robert Rubin’s strong dollar policy – has
only been a countertrend rally in a bear market. It appears that
the US Dollar Index is about to rejoin its major trend. Once again,
the important US Dollar Index levels to watch are 117, then 115,
then 112.
SEA CHANGE IN DOLLAR
POLICY?
Recently the Bush
administration imposed tariffs on steel. As a friend of mine
observes, this signals that the Bushites are under pressure to help
US manufacturing and dam up the flood of cheap imports. As I said
above, the Rubin’s high dollar policy has acted exactly as if the
world had placed huge import tariffs on all US made goods. They
then re-cycled their glutting dollars back into US financial
markets, fuelling the stock market boom, making Clinton and Rubin
look like geniuses, and of course making lots and lots of money for
Rubin’s buddies on Wall Street. The huge trade deficit was eating
out the country’s guts and destroying US industry, but, hey –
apres moi, le deluge. Who cares as long as I get mine?
Besides the Bushite
tariffs on steel, on 3/26/02 New York Federal Reserve president
William McDonough (an Insider if ever there was one) remarked that
the dollar was “a little overvalued.” Then the president of the
Dallas Fed, Robert
McTeer, said the Federal Reserve was in no hurry to tighten, which
also hints at a lower dollar. Count on it, when Federal Reserve
presidents make comments like this, it isn’t because they just
greased their jaws. They have a purpose, namely, to talk down the
dollar.
MORE
TECHNICAL CONSIDERATIONS
In his
4/5/02 electronic newsletter John Mauldin (www.200wave.com)
presented a handy summary of a currency manager’s problems with the
dollar, woven around the symbol of a glacier. The dollar’s deficit
is the glacier slowly moving down the mountain. In its path it will
leave a huge valley.
Using
Morgan Stanley data Mr. Mauldin noted that the present US trade
deficit is about 4.3% of US Gross Domestic Product, and projected to
rise to six percent (6%) in 2003. Call that nearly $2 billion per
day or $600 billion plus per year. This, as economists like to
intone, is “unsustainable.”
However the trend of recycling these dollars into stateside
investments appears to have peaked, although this has not yet hit
the dollar’s exchange rate. Why not? Because the Asians have been
sending more dollars back to the US. The Asians are in a panic to
keep their currencies from appreciating against the dollar or any
other currency so they can keep up their cheap exports to the US.
Back
to the US. A Federal Reserve study shows that when any country’s
trade deficit exceeds 5%, the currency starts to drop and typically
sinks 20% over the next three years. Mauldin’s conclusion? If the
deficit rises to 6% next year and the Fed study is right, then
before the deficit hits 6% the dollar will begin to fall. He
estimates that could begin later this year, and could lop 3% from
this year’s GDP.
AND
THAT MEANS?
When
people sell any currency, they have to buy another. What are the
alternatives to the dollar? Let’s see . . .the yen, headed for 150
to the US dollar and maybe further down as the Japanese try to
revive the 12-year dead corpse or their economy. Oh, and there’s
the Euro, which since introduction in 1998 at $1.18 = one euro has
dropped – or should I mimic a central banker and remain stylishly
impenetrable by calling it “negatively appreciated” – to under
US$0.90.
Are
there any other alternatives? Yes, primarily gold and then silver.
As alternative currencies to the US dollar, they will reap the big
benefits from dollar weakness.
-- F.
Sanders
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