How to Sell the Dollar, Part I

Today, the updated version of Addison’s Demise of the Dollar – And Why It’s Even Better for Your Investments hit #1 on Amazon’s nonfiction bestseller list. Read an excerpt from Addison’s bestseller, below…

In 2004, then Treasury Secretary John Snow was traipsing about the globe trying to “talk the dollar down.” Why? In a word: debt. At the time, our debt stood at $7 trillion, with interest payments in fiscal 2003 totaling $318 billion. But now the U.S. national debt stands above $ 9 trillion, with interest payments in fiscal 2007 adding $ 1.4 billion a day.

But the Fed and Treasury have engineered a strategy to pay off the debt with weaker and weaker dollars. And guess what? So far, so good. Since November 2002, the dollar has fallen against the euro more than 50 percent since its high in October 2000. Of course, this is not the first time we’ve gone through a managed devaluation of the currency. In the 34 – year period since Nixon slammed the gold window shut and subsequently ended the Bretton Woods exchange rate mechanism, we’ve had only five major currency trends:

1. Weak dollar 1972 – 1978 (7 years)
2. Strong dollar 1979 – 1985 (7 years)
3. Weak dollar 1986 – 1995 (10 years)
4. Strong dollar 1996 – 2001 (6 years)
5. Weak dollar 2002 – (? years)

The most notable period spanned the 10 years from 1986 through 1995. Then as now, the United States was fighting a historic current account deficit through managed debasement of its currency. But because the present bear market only began in February of 2002, the current cycle looks like it still has a number of years to run.

In the best-case scenario, if the current bear market follows the trajectory set by the 1986 – 1995 slump, we could see a weakening dollar for up to 10 years. This presents an opportunity for selling the dollar in one of four ways: direct and indirect speculations, using short- and long-term options for each. These plays will help you safely position your money outside the dollar bear market. And you stand to make a fair amount of money, too.

But there is great danger ahead. Since the trade deficit passed the $ 759 billion mark – 6.3 percent of GDP – foreigners now must shell out about $ 1.5 billion a day just to keep the dollar afloat. And even during the managed dollar decline of 2003, the trade imbalance continued to grow. In 2005, Stephen Roach, Morgan Stanley’s chief global strategist, predicted that the current account deficit at the time was on course to reach $ 710 billion – 6.5 percent of GDP. He was short by only a few billion.

Herein lies the drama. The Bank of Japan spent the equivalent of $187 billion in 2003 – and $67 billion in January 2004 alone – in a bid to prevent its strengthening currency from choking off the country’s export-led recovery. In dollar terms, the Bank of Japan is now spending more than $ 1.5 billion every day trying to keep the yen from strengthening against the greenback.

Over a four-week period in the fall of 2003, combined foreign central bank purchases of U.S. securities topped $ 40 billion, more than $ 2 billion every trading day. Yet these central bank billions managed merely to limit the greenback’s decline to just 2.3 percent over the same period. Can you imagine what would have happened if the banks hadn’t pumped that money into the Fed’s reserves? One former currency trader has asked, “If $40 billion cannot bring about even a minor rally, just how weak and despised is the once – almighty dollar?”

We have relied on the kindness of strangers for too long. “We’re like the untrustworthy brother – in – law who keeps borrowing money, promising to pay it back, but can never seem to get out of debt,” Jim Rogers writes. “Eventually, people cut that guy off.”

There is no way the United States can possibly pay off its creditors should they decide to cash in their IOUs. Right now, the United States holds only about $ 70 billion in reserves against its obligations – much less than 2005’s $ 87 billion. That would last about three minutes should creditors begin to sell the dollar, rather than trying to support it.

It’s hard to imagine, isn’t it? The world’s reserve currency spiraling downward, out of control. But then, that’s what the British must have thought in 1992 when they attempted to manage a devaluation of the pound. Despite the Bank of England’s best efforts, sterling got away from them; the currency collapsed and Britain was kicked out of the Exchange Rate Mechanism (ERM) established to pave the way for the euro. On that day, known as Black Wednesday in Britain, currency speculator George Soros is rumored to have made as much as $ 2 billion. Don’t be surprised if more fortunes emerge in the future as the dollar slips dangerously close to free fall.

By flooding the system with liquidity, the Fed cannot control the value of the U.S. dollar against foreign currencies; nor can they control its purchasing power – at least not indefinitely. The Fed’s current policies can “give the majority of investors the illusion of wealth as asset markets appreciate, ” wrote Marc Faber in November 2003,  “while the loss of the currency’s purchasing power is hardly noticed. This is particularly true of a society that has a very large domestic market, where 90 percent of the people don’t have a passport and therefore know little about what is going on outside their own continent.  And where the import prices of manufactured goods are in continuous decline because of the entry of China, as a huge new supplier of products with an extremely low cost structure, into the global market economy.” If that’s the case, you should look at any declines in the dollar as an opportunity to make some money.

The dollar is the single biggest element of risk in the world of finance today. Rearrange the current system of world finance ever so slightly, let confidence in the greenback falter, and the mighty dollar could go up in flames. There are many ways to hedge against this risk. Better still, there are many ways to profit from the likelihood the dollar will fall. Some methods are direct, some indirect. Some are leveraged, some unleveraged. There is a methodology for every taste, but before explaining the specifics, we ask: What ails the dollar?

The dollar is a victim of its own success. It is America’s most successful export ever – more successful than chewing gum, Levi’s, Coca – Cola, or even Elvis Presley, Britney Spears, and Madonna put together. Trillions of dollars flow through the global financial markets every week, and they are readily accepted at large and small – and clandestine – business establishments from Kiev to Karachi.

Today, there are simply too many dollars in circulation for the currency’s own good. Why? Americans have been living beyond their means for more than two decades. The U.S. dollar’s problems stem from a single cause. “If there’s a bubble,” wrote David Rosenberg, chief economist at Merrill Lynch, ” it’s in this four – letter word: debt. The U.S. economy is just awash in it. “

You’ve seen it firsthand: John Q. Public now holds more credit cards and outstanding loans – with a higher and higher total debt load – than ever before. Outstanding consumer credit, including mortgage and other debt, reached $ 9.3 trillion in April 2003 – a significant increase from its $ 7 trillion total in January 2000 – but by the third quarter of 2007, debt had nearly doubled since 2000, to $ 13.7 trillion. With consumer spending alone responsible for approximately 70 percent of U.S. GDP, that’s quite a hefty personal debt load.

The corporate debt picture is no better. American companies have never depended so much on sales of their corporate bonds. Between 2002-2007, investment – grade corporate bond sales increased nearly 60 percent, growing from $598 billion to $951 billion. But junk bond sales for that same period broke the bank, surging from $57 billion to $133 billion.

The third leg of the debt problem, following consumer and business debt, is Uncle Sam. Government debt as of November 7, 2007, officially passed $ 9,000,000,000,000. That’s about $ 30,000 for every man, woman, and child in the country. This total includes debt owned by many types of investors, from individuals to corporations to Federal Reserve banks and especially to foreign interests. (By 2004, foreign central banks had stockpiled more than $ 1.3 trillion worth of dollar – denominated Treasury bonds and agency bonds at the Federal Reserve. By 2007, foreign debt had nearly doubled, to $ 2.033 trillion.)

What the $ 7.8 trillion figure does not account for are items like the gap between the government’s Social Security and Medicare commitments and the money put aside to pay for them. If these items are factored in, the government debt burden for every American rises to well over $ 175,000. In 2005, the Methuselah of investment mavens, Sir John Templeton, then 93, said you should get out of U.S. stocks, the U.S. dollar, and excess residential real estate. Templeton believed the dollar would fall 40 percent against other major currencies, and that this would lead the nation’s major creditors – notably Japan and China – to dump their U.S. bonds, which would cause interest rates to run up, thus beginning a long period of stagflation. He was right.

Don’t let his age fool you – Templeton was still sharp in 1999 when the financial industry hacks in Florida were urging their customers to buy more tech stocks. Templeton warned that the bubble would soon burst. He was right; they were wrong. Of course, he was only 87 back then. He is almost certainly right again. Other great investors, too, are getting out of the dollar. For the first time in his life, Warren Buffett is investing in foreign currencies.

George Soros, who made a fortune selling sterling in the 1992 ERM crisis, warns that the U.S. system could ” blow up ” at any time. Richard Russell, the influential editor of the Dow Theory letters, speaking at the New Orleans Investment Conference, warned: “If ever there was a crisis that could shake the global economy – this is it.” Jim Rogers is teaching his daughter to speak Chinese. When old – timers nod their heads in agreement – especially when they happen to be the most successful investors in the world – their advice may be worth listening to.

American consumers, companies, the U.S. government, and the country as a whole owe more dollars to more people than ever before. But perhaps the greatest threat to the U.S. economy is its foreign creditors. There is – or should be – a limit to the number of dollars foreigners are willing to buy and hold and thus a limit to their willingness to service our credit habit. Why? Because the United States, while still the world’s number – one economic power, is showing itself to be an unreliable steward of its own currency.

Regards,

Addison Wiggin
The Daily Reckoning

April 30, 2008

Addison Wiggin is the editorial director and publisher of The Daily Reckoning, and executive publisher of Agora Financial, a multi-million dollar financial research firm and publishing group based in Baltimore, Maryland.

Today’s Daily Reckoning will be a bit light. First, we don’t have much to say…and second, because we have no time to say it anyway.

As to the first issue, nothing much happened yesterday. The Dow retreated only 39 points. Oil slid only $3, to $115. The dollar rose slightly – to $1.55 per euro. Only gold seemed to want to go somewhere – down $18.

As near as we can figure, most investors think the worst is over. After a correction, stocks are going back up. The dollar too. Gold, meanwhile, is going down. Bernanke, Bush and the whole company of angels and archangels who watch over our economy and our money are winning, they believe.

But the more they win…the more you lose, dear reader. Because there are mistakes that need to be corrected. There are errors that need to be punished. Truth needs to be discovered.

And the longer the correction is delayed…the more we live in darkness and error, and the more it costs to fix things. You don’t have to be an economist to figure this out. It’s just the way the world works.

We ended yesterday’s note by reminding ourselves what money really is. When a bank makes an electronic transfer, electrons are the only thing that crosses a street. But those electrons represent pieces of green paper…which, in turn, represent wealth. And what is wealth? It is limited resources…the potential to take up some of the world’s coal, iron, plastic…anything from a ton of wheat to a brand new Mercedes…to some working man’s time. The problem, fundamentally, is that the credit expansion of the last 25 years gave too many people too many claims against those limited resources. Then, when they went to exercise those claims – against stock market earnings in the ’90s…then against houses in the early ’00s…and now against oil, rice and gold – prices rose. The rising prices sent a phony signal. They convinced investors that there was more demand for dotcom stocks and houses than there really was. And today, they’re signaling an outsize demand for commodities and gold. As money pours into the bubble sector…more and more resources – time, capital, things – are misdirected away from things people really want and need and into the bubble. Eventually, the bubble pops…losses are taken…and rebuilding can begin a firmer foundation.

‘But wait,’ we anticipate your question, ‘are you saying that commodities are going to crash too?’

Yes…of course. Every farmer in the world is working hard to make it happen. Lured by high prices, they are bound to overproduce. They always do. Over-production is, by definition, a mistake. It will need to be corrected, eventually…just as overbuilding of new houses is being corrected…and just as overinvestment in NASDAQ dotcoms needed to be corrected.

In the case of commodities, however, as Jim Rogers pointed out in yesterday’s guest essay and as our own commodities guru, Kevin Kerr tells us: commodities may correct…but they will never go to zero. The demand for things that power the world will never go away. We will always need grains…sugar…beef…corn. The key to commodities trading, Kevin is wont to tell us, is making informed, calculated decisions.

*** The correction in the housing market made its sharpest move ever in February, with houses nationwide down 12.7% from 12 months earlier. In Las Vegas, Miami and Phoenix prices were down 20%. Foreclosures doubled in the first quarter, with Nevada leading the way.

The falloff in housing has cast a shadow over the whole consumer economy. Consumer confidence is at a 5-year low. The LA Times tells us that people who live on tips – such as waitresses and bellhops – report that clients are tighter with their money than they used to be. Even the big spenders are less willing to part with their money. Says the Rocky Mountain News: “millionaires are singing the recession blues too.”

But let’s go back to commodities, oil and gold. Just because there will eventually be a correction in these markets doesn’t mean it is going to happen tomorrow.

Let us turn to the case of gold, for example. Yesterday’s close left the price at $876. If we’re right, a lot of investors and speculators are beginning to worry. We bought most of our gold when the price was below $500. But many of these guys got into the gold market at $800 and above. Some have already lost money. Others are worried about preserving their gains. Even a few of the old-timers are recalling the terrible bear market in gold of ’80-’99. They lived through it; they won’t live through it again, they say to themselves.

But even at $900…or $1,000…gold has still not gotten to the silly stage of a bull market. That is, it is a bull market…but not a bubble. The charts show a steady rise in the price, but no vertical spike.

And, as we’ve pointed out many times, a lot has happened since ’80. Simply adjusting the ’80 price to inflation, gold would have to sell for nearly $2,500 in today’s money to return to its previous high. But inflation of the dollar is only a part of the picture; a bubble in the credit markets has led to trillions of dollars worth of derivatives …trillions of dollars’ worth of new debt…trillions worth of dollar reserves in China, Japan and Russia…dizzy prices for “works of art”…madcap building projects in the Mideast…breathtaking growth in China…and more debt than the planet has ever seen. Many of these prices and projects must be mistakes. Many will have to be corrected.

The Fed should raise rates…and bring on the correction. But that’s not going to happen, because another very important difference between ’80 and ’08 is the difference between Paul Volcker and Ben Bernanke. Volcker protected the dollar – which is why gold entered a 2-decades long bear market. Bernanke has no interest in protecting the dollar – which is why this bull market in gold has a long way to go. Instead of correcting the mistakes of the last 20 years, the Bernanke Fed is determined to help people make more of them.

*** What the United States lacks, Europe seems to have. A positive trade balance, for example. Savings too. A rising currency. And a central bank chief more like Volcker than Bernanke.

*** “The U.S. is doing most of what it told Asia not to,” writes William Pesek. “It counseled higher interest rates, stronger currencies, fiscal belt-tightening, avoiding fresh asset bubbles and limits on bailing out investors. These days, the U.S. is reminding the world it’s better at giving economic advice than taking it.”

*** “An inconvenient debt” reads a headline in today’s Baltimore Sun. The writer was referring to I.O.U.S.A., which has been called the “Inconvenient Truth of the economic world more than once.” The article goes on to talk about not only the documentary, which will have three screenings at the Maryland Film Festival this weekend, but also Agora Inc., and your lowly editors, as well.

That’s all for today…

Bill Bonner
The Daily Reckoning