December 14, 2010
Why the Dollar Bears Are Wrong
With the Federal Reserve printing 100 billion new dollars each month (that they admit to) it makes sense that the purchasing power of your dollars will become less and less as the supply of dollars grows and grows. However, the really obvious outcomes seldom come to pass when investing, making this seem like a crazy business.
Keep in mind that the value of any currency can only be measured against the value of other currencies. All currencies can’t go down at one time. One (or hopefully more) must go up as others go down.
So let’s see why I think the bears are wrong when it comes to the dollar.
When compared to the Euro-zone, our problems don’t seem all that bad. Our banks have been propped up and made solvent over the past two years. In Europe they have yet to deal with most of their financial problems. Score one for a dollar that should rise vs. the Euro.
The other major currency is the Yen, which oddly enough has been extremely strong for years now, rising 40% in dollar terms since early 2007. This is despite a really funky stock market over there that is still 30% below its 2007 highs.
If you think our federal debit is bad, Japan’s debt totals 120% of their GDP, or annual economic output, about twice the debt level that other developed countries carry. Even the much maligned US federal debit is only 80% of our GDP. Score one for a dollar that will likely get stronger vs. the Yen.
What other major currencies are there? The value of the Chinese Remnimbi (or Yuan) is officially pegged to the value of the dollar, so it does not fluctuate. Call that one a draw.
Many consider gold a currency, but unlike most currencies, it has an extremely limited supply. According to goldpreciousmetals.com all the gold in the world would fit in a room 63 feet by 63 feet by 63 feet. I hope that room has strong floors.
This limited supply of gold means that other uses, such as jewelry, medical and industrial purposes may greatly affect the price of gold along with what might be considered a currency valuation. Also, when times get tough, gold gets sold. Look at the stock market crash of 2008 when gold dropped to the $700 range and you will see what I mean. In spite of the extenuating circumstances, gold has risen over the past few years, so let’s score one for gold being strong vs. the dollar.
So far we have a score of 2 for the dollar, 1 for gold and one tie. But what the dollar has been doing ought to count for something, too.
The Dollar Index, which compares the dollar to a basket of currencies, hit its lowest point ever 2½ years ago and has been rising since then. The facts are that the dollar is rising; however one would never suspect that from the popular news reports.
I had breakfast a few years back with Richard Russell and his wife Faye. Richard has written the popular Dow Theory Letters for 55 years and lends great perspective to any conversation. He made a comment to me that morning which has stuck with me ever since. He said that the debt we have piled up all around us will create huge demand for dollars because people need dollars to pay their debts.
Professional traders would call this a “short” on the dollar. Shorting is borrowing an investment and selling it to buy it back at a lower level, repay what you borrowed and pocket the difference. Shorts make money when a market falls, but lose if the market moves up.
At some point, investors who are short are forced to buy back the investment to repay the IOU they created. If there are a lot of short-sellers and the market moves up, it can create a buying frenzy as short sellers “cover their shorts”.
This powerful type of buying trend is called a short-squeeze and can be a gift to those on the right side of it but can wipe out those “caught short”.
Right now, the dollar may be experiencing the mother of all short squeezes.
Considering the pile of debt we have in this country, the short-squeeze that Richard Russell pointed out will be affecting the market for dollars for a very long time. Score another point for a rising dollar as debt repayment creates demand for dollars.
My final point is that as an optimist, I have to say that anyone who has bet against the future of the United States has always lost. I don’t think things have changed in that regard.