How to Sell the Dollar

In 2004, Treasury Secretary John Snow was traipsing around
the globe trying to "talk the dollar down." Why? In a word:
debt. The U.S. national debt stands at about $7 trillion,
with interest payments alone in fiscal 2003 totaling $318
billion.

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 25 percent against the euro, and more than 50% 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 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 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 be 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 a great danger ahead. Since the trade deficit
has passed the $500 billion mark – nearly 6 percent of GDP
– foreigners 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. Stephen Roach, Morgan Stanley’s chief global
strategist, predicted that this current account deficit was
on course to reach $710 billion – 6.5 percent of GDP.

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 economy.
In dollar terms, the Bank of Japan has been spending $1
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 that $2 billion every trading day. Yet
these central bank billions have merely managed to limit
the greenback’s decline to just 2.3 percent over the same
period. Can you imagine what would have happened had the
banks not pumped that money into the Fed’s reserves? One
former currency trader asked, "If $40 billion can not 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 just cut that guy off."

There is no way the United States can possibly pay off its
creditors should they decide to cash in their IOU’s. Right
now, the United States holds only $87 billion in reserves
against its obligations. 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 the day, know 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.

Did You Notice…?
by Carl Swenlin

Decision Point’s Rydex Cash Flow Ratio differs from the
Asset Ratio in that it is based upon a cumulative total of
daily net cash flow for each of the Rydex mutual funds, not
raw asset levels. The Cash Flow Ratio is calculated by
dividing the total bear fund cash flow plus money market
cash by the total bull and sector fund cash flow.

As you can see on the chart, the Ratio (first panel below
the S&P 500 graph) has been in a trading range for nearly
three years, and the bottom of that range has been a
reliable measure of bearish excess sufficient to signal
important price bottoms.

Once again the Ratio is approaching the bottom of the
range, and bearish cash flow (bottom panel on the chart) is
near record high levels. Moreover, this sharp increase in
bearish sentiment has occurred with only a minor price
decline — people have gotten too bearish too fast. All
this should send up warning flags to the short sellers.

Having said that, let me point out that it is entirely
possible for prices to head lower and for bearish cash flow
to punch through the resistance to new highs, causing the
Ratio to break through the bottom of its range. Also, the
failure of bullish cash flow to follow prices to new highs
presents a serious negative divergence, indicating that
participation has faded significantly.

Nevertheless, the most obvious thing I see on the chart is
that sentiment has gotten bearish too quickly, and that is
not good news for the bears.