Brokedown Greenback

The Daily Reckoning – Weekend Edition

Wow, the dollar has certainly taken a beating this past week following the Fed’s rate cut. It has fallen to a 15-year low in the world dollar index, hitting the weakest level ever against the euro at just under $1.40. Ouch.

Kicking the dollar while it’s down is the price of crude oil – which has broken through $80 a barrel. It used to be that oil and the dollar would rise and fall in step with one another – but for over four years, reports Bloomberg, this has not been the case, the price correlation between the two has been negative. In late 2002, the price of oil was $19 a barrel – and the dollar was worth 39% more against the euro and other major currencies.

Bloomberg reports:

"’Oil exporters’ propensity to import from the U.S. has declined in recent years, while their tendency to import from Europe and Asia has risen steadily,’ says Stephen Jen, global head of currency research for Morgan Stanley in London. OPEC nations currently buy more than three times as much from the European Union as from the U.S., he says.

"To the extent that oil exporters keep buying European, Europe’s economy may be less affected by higher oil prices than the U.S. economy, prompting investors to favor European investments. And since oil imports account for about a third of the U.S. trade deficit, ‘high and rising oil prices may be particularly bad for the dollar,’ Jen says."

Also wearing on the greenback are rumors that the Saudi Arabian government are batting around the idea of de-pegging their currency, the riyal from the U.S. dollar – a move that would be a disaster for the already down-and-out U.S. currency.

London’s Daily Telegraph reported late last week that "Saudi Arabia has refused to cut interest rates in lockstep with the U.S. Federal Reserve for the first time, signaling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East."

However, Saudi government officials are vehemently denying this report. Ihsan Bu-Hulaiga, head of a government-appointed finance committee that advises King Abdullah had this to say:

"It’s not necessary that there will be a de-pegging of the riyal from the U.S. dollar, not in the near future. The issue is that we have an abundance of liquidity in the economy."

Still, not everyone is convinced – and the possibility of this situation occurring would not only be "catastrophic" for the dollar – but for the U.S. economy as well, points out Byron King in a recent post on the DR blog.

"From the standpoint of grand strategy, four years of U.S. war in Iraq, as well as near 40,000 US casualties, could all be for naught if the dollar decouples from the price benchmark for oil," writes the Outstanding Investments editor.  "It will be utterly calamitous to the U.S. position in the world.

"What is one to do?  For now, buy gold.  And accumulate silver.  If possible, take delivery and bury the treasure in your back yard."

Byron isn’t the only one who thinks gold as protection from a crumbling dollar and as a general hedge against a risky marketplace is a good idea. In the last month, the precious metal has gained 12%, or around $80 an ounce, coming near highs not seen in 27 years.

Gold is "an asset that people want to own as protection for risks they can’t really analyze and get their arms around," said Mr. Schweitzer at JPMorgan.

On that note, think of the risk in the markets as comparable to trying to hug your crazy 300-pound Aunt Emma at a family reunion – there’s no way of getting your scrawny little arms around that. And then buy some gold.

Short Fuse
The Daily Reckoning
September 22, 2007

P.S. If you are interested in padding your portfolio with gold – but feel like maybe the price is getting too high, fear not. There’s a way you can get in for one penny per ounce. No joke. And you can make four times your money – even if the price of gold stays exactly where it is.

— The Daily Reckoning Book of the Week —

Demise of the Dollar…and why it’s great for your investments
by Addison Wiggin

This acclaimed book spent over a week in the #1 slot on Amazon’s bestseller list – knocking Harry Potter to number two. It then showed up on Barnes and Noble’s bestseller list and debuted on The Wall Street Journal’s Business bestseller list last week at #8!

The only logical next step was for the book to get on the New York Times bestseller list…which it and sat strongly at #5!

The Demise of the Dollar examines the reasons for the dollar’s slide – including the nation’s historic trade deficit, the euro, government spending habits, globalization, and other international factors – and offers an up-close look at the Federal Reserve’s attempts to "manage" the dollar’s value.

To purchase your copy, see:

The Demise of the Dollar

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THIS WEEK in THE DAILY RECKONING: This was a must-read week of your favorite online publication – but no worries if you missed an issue. We have all the insights, anecdotes and ‘sardonic humor’ that you have grown to love, catalogued for you below…

The Mystified Economic Explorer                                 09/21/07
by Bill Bonner

"An economic explorer…arriving, like Columbus, on the shores of our New World Financial Order…would be amazed, puzzled, impressed…and completely lost. He would see before him…things he never before imagined or thought possible."

An Economic ‘Ground Rush’                                         09/20/07
by Bill Bonner

"A 15% loss would be the equivalent of a $3 trillion loss in household wealth. That would be a whole lot of ‘flation’ taken out of the system…and a hard-landing for the millions of people who’ve been floating in air for the last 20 years."

Drinks are on the Fed                                                   09/19/07
by Bill Bonner

"The Bank of Ben Bernanke has announced that it is not the Bank of Paul Volcker; it is still the Bank of Alan Greenspan…of the two forms of ‘flation’ we talked about yesterday, it prefers the form preceded by ‘in’ rather than ‘de.’"

Greenspanning the Breadth of Responsibility                09/18/07
by Bill Bonner

"Alan Greenspan came out with his own book on Monday – The Age of Turbulence. Not a very good title, in our opinion. Still, it is sure to knock our own tome off the shelves. Everyone wants to know what the Maestro was really thinking."

Slippery Oil for Solid Gold                                            09/17/07
by Bill Bonner

"For the last 30 years, the baby boomers have been up-scaling their lives. If our friend is right, the next years will be spent down-scaling….getting rid of things…simplifying…and focusing on things not directly related to money."

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FLOTSAM AND JETSAM

Time to Shine
by Puru Saxena

Precious metals are on the verge of a major rally within their ongoing bull-market. After consolidating since May 2006, both gold and silver spent the past 16 months building large bases and now it seems that the much anticipated advance has arrived.

I started investing in precious metals in 2001 when both gold and silver were significantly cheaper, however even today they represent great stores of value for the long-term investor.  In a world of high monetary inflation and elevated asset prices, precious metals are still relatively inexpensive when compared to financial assets such as bonds, non-resource related stocks and leveraged real-estate.

It is interesting to note that the S&P500 outperformed gold throughout the 1980’s and 1990’s.  Back then, US financial assets witnessed their biggest bull-market as the world of tangibles contracted. During that period, US stocks rose 15-fold whilst gold’s value declined by roughly 70%.  However, at the beginning of this decade, the mega trend reversed in favour of gold.  And since then, the yellow metal has appreciated much more than the S&P 500.

Now, in order to determine what the future might bring, I would like to analyse the current situation.   Over the past few months, the media has bombarded the public with the "Sub-prime Crisis" and the ongoing credit crunch in some segments of the capital markets.  All this negative news has caused investors to panic and the "deflationary bust" debate is back in fashion once again.  Several analysts have also started to lean over in the deflation camp and are advising investors to liquidate en masse and raise cash.  So, should we also join the herd and panic?  Or is this the time to reflect and ascertain how the establishment will respond to the ongoing crisis?

I am of the opinion that over the weeks and months ahead, the US establishment and various central banks will orchestrate a massive monetary and fiscal bail-out.  Remember, we are in the third year of the US Presidential cycle and the people in power will do whatever they can in order to inflate asset-prices heading into the election.  In fact, Mr. Bush’s recent "aid program" to help low to middle-income homeowners is a good indication of what lies ahead.  If my assessment is correct, another bout of widespread inflation (money-supply and credit growth) will come to the "rescue" as the central bankers open the monetary spigots and flood even more liquidity into the ailing monetary-system.

It is worth noting that after the technology bubble burst in March 2000, the Federal Reserve created massive inflation through its ultra-loose monetary policy.  And this easily available credit found a home in real-estate all over the world.  After being burnt in the stock-market, the investing public decided to direct their speculative juices towards bricks and mortar.  As easy money flowed thanks to record-low interest-rates, home prices were bid up in the majority of countries.  There was a total disregard for risk as the "real-estate never goes down" mantra replaced the "New Economy" nonsense.  This party continued for a while until the "bubble-blowers" decided to remove the punch bowl by raising the cost of borrowing.  As the tide of liquidity went out, numerous people were found swimming naked!  The "Sub-prime Crisis" had arrived.

Now, given the fact that the masses have lost a lot of money in technology and real-estate, it is highly unlikely that the next bout of central bank sponsored inflation will benefit these sectors of the economy.  In other words, the next bubble is not likely to form in these previously "hot" markets.  In fact, this time around, I suspect the easy-monetary policy will create a gigantic bubble in precious metals and other natural resources.  Already, it seems as though the market senses the next wave of inflation as the US Dollar is declining and gold has broken above US$700 per ounce.  In the period ahead, I expect gold to appreciate significantly not only against the US Dollar but also against the other currencies which are being inflated at a ridiculous pace!  Take a look at the annual money-supply growth rates around the world –

US                   +12%
Euro zone         +13%
Britain             +14%
China               +20%
Russia              +51%
India                 +23%
S. Africa           +22%
Brazil                +12%

Now, you don’t have to be a NASA-scientist to figure out that as the quantity of money increases, each unit of money will continue to lose its value or purchasing power against assets whose supply cannot be increased at the same pace.  This confiscation of purchasing power has bullish implications for precious metals.

Today, several highly-intelligent economists and analysts are anxiously waiting for "The Crash" which will wipe out the value of the Dow Jones by 50-60%, cut the value of gold by half, cause an economic depression and create a vicious bear-market in asset prices.  In my humble opinion, these people are going to be disappointed because "The Crash" will be stealth and will take place via plummeting currencies rather than an outright collapse in nominal asset-prices.  Those who are forecasting a significant decline in US asset prices need to look no further than Zimbabwe where stocks have been making record-highs, albeit in a collapsing currency!  So, given a choice between an outright deflationary bust and an inflationary bail-out, I can assure you that every establishment will opt for the latter outcome.  In fact, central banks will continue to print money until the world runs out of trees.

The truth is that most people do not understand inflation and feel wealthy as long as their asset-prices continue to rise (never mind the state of the currency).  So, the inflation-pill is a lot easier to swallow than an economic depression.  And this is exactly what we are going to witness.

The modern-day monetary system is far from ideal, however we all have to live within the system and try our best to protect our wealth from the ravages of inflation.  As a money-manager with the capability to invest in global assets, I have invested our clients’ capital in the world of tangibles.  Recently, we have added to our positions in precious metals on the belief that we could witness an explosive run-up over the coming months.  Furthermore, from a sentiment perspective (with the majority of investors fearful and bearish), the current conditions seem ideal for the next advance in the ongoing secular bull-market in precious metals.