Is the Dollar Heading Up Or Down?

Arguments for a Long-Term Devaluation of the Dollar

Unless you’ve been living in a cave, you know that the dollar is losing its status as world reserve currency.

Many governments and international organizations are feverishly working to get away from the dollar into another reserve currency, or basket of reserve currencies.

Indeed, today’s rumor is that the Middle Eastern oil producers, plus China, Japan and France have all agreed to start trading oil using a basket of currencies – instead of the dollar – starting in 9 years. See this explanation for why the governments are denying the rumor.

AFP points out that – whether or not the rumor is true (see this) – confidence in the dollar is so weak that investors and banks are using it as an excuse to get out of the dollar.

Many investors plan on staying in the dollar as long as China is buying U.S. treasuries. No one wants to get out early, but no one wants to be left holding worthless monopoly money if and when China pulls the plug.

Many people – including me – try to read the tea leaves by monitoring the volumes of T-bonds, T-bills and T-notes China is buying. For example, see this and this. But that is a tough game to master, partly because China’s economic leaders aren’t dumb enough to telegraph their punch too early..

And remember, China isn’t the only player. For example, Abu Dhabi, Saudi Arabia, Kuwait and Qatar together hold an estimated $2.1 trillion in dollar reserves by themselves. If those 4 countries dumped the dollar, so would the rest of the world.

The private sector has already been moving away from the dollar. As the Globe and Mail noted in early 2008:

A UBS Investment Research report says that while it would be wrong to write off the U.S. dollar as the global reserve currency, its roughly 90-year iron grip on that position is loosening. “The use of the U.S. dollar as an international reserve currency is in decline,” said UBS economist Paul Donovan.

“The market share of the dollar in international transactions is likely to decline over the coming months and years, but only persistent policy error – or considerable fiscal strain – is likely to cause the dollar to lose reserve currency status entirely.”

The UBS report maintains that the gradual slide of the U.S. dollar is being driven not by the world’s central banks, but by the private sector, as individual companies increasingly abandon the greenback as their international currency of choice.

“The private sector’s use of reserves is more important than official, central bank reserves – anything up to 20 times the significance, depending on interpretation,” Mr. Donovan said. “There is evidence that the move away from the dollar as a private-sector reserve currency has been accelerating since 2000.”

As David Bloom, currency chief at HSBC, says:

Everybody in the world is massively overweight the US dollar. As they invest a little here and little there in other currencies, or gold, it slowly erodes the dollar. It is like sterling after World War One. Everybody can see it’s happening.

Because there is a premium to the value of whatever currency is the world’s reserve currency, the value of the dollar will decline in the years ahead.

In addition, Bernanke and the boys are running the printing presses 24/7, the banks have been given trillions to gamble with, the U.S. is running massive deficits with a massive debt overhang, the Fed is buying U.S. treasuries and the boys are engaging in various forms of quantitative easing, and the government is doing just about everything in the text book to lead to dollar devaluation.

As HSBC’s Bloom says:

In the US they have near zero rates, external deficits, and public debt sky-rocketing to 100pc of GDP, and on top of that they are printing money. It is the perfect storm for the dollar.

Finally, investors are buying dollars at zero percent interest and – in a carry trade – using the dollars to invest abroad. This also devalues the dollar.

Arguments for a Short-Term Dollar Rally

So we should all be long other currencies (or gold) and short the dollar, right?

Maybe. But let’s look at the other side of the argument.

First, there are strong arguments for deflation for the short, and perhaps medium or even long-term. In deflation, every dollar buys more goods, and so the value of the dollar may rise in the short to medium-term.

Second, Marc Faber thinks the U.S. dollar is no longer overvalued at present levels, and that there might be a snapback rally for the dollar resulting from oversold levels.

Third, the inverse relationship between the dollar and stocks is well documented. And many commentators see a stock market decline ahead.

For example Roubini thinks stocks are overbought and will decline.Moreover, most Elliot Waver timers – such as Prechter, McHugh, Daneric and Mish – think we’re probably in for a huge “wave c down” stock market crash in the near future. Indeed, quite a few e-wave theorists are convinced that we’re about to experience the end of a “grand supercycle“, which means that stock values will crater.

Finally, very few predicted that the dollar would rally last year. But it did. And not only because people considered dollars or U.S. treasuries a safe haven. But also because of the huge margin calls, need to liquidate assets fast, and the urgent necessity of raising dollars to settle dollar-denominated contracts. In other words, another severe financial crisis could lead to another short-term dollar rally.

Bottom Line

The bottom line is that the dollar will get creamed in the long-run, but will probably rally whenever the next major stock market crash or next severe leg of the financial crisis occurs.

Whether you think that will happen quickly or sometime in the future is your call.

Note 1: There are obviously many other factors affecting the dollar as well. For example, if other countries cut their interest rates to zero and print as much money as the U.S., then the dollar will look a little better in the currency beauty show. If other countries raise interest rates and soak up excesses in the monetary supply, then the dollar will get somewhat uglier. The British pound sterling is hideous, and may be even worse than the dollar.

A default by another major economy may also make the U.S. look better.

The currencies of commodity-centric countries such as Brazil and Australia tend to rise when commodity prices rise, and fall when commodity prices decline.

There are other important factors as well.

I am not an investment advisor and this should not be taken as investment advice.

Update: HSBC’s Bloom provides a contrarian view to how the dollar will perform in the next crash:

The dollar rallied last year because we had a global liquidity crisis, but we think the rules have changed and that it will be very different this time [if there is another market sell-off].

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  • http://www.blogger.com/profile/17619597021388228806 Brian Barker

    A recent CNN television broadcast gave the impression that Esperanto aims to be a single global language. The comparison was with a global reserve currency instead of the US dollar.See http://jeffreyhill.typepad.com/english/2009/09/video-global-currency-global-language.html#tpe-action-posted-6a00d8341d417153ef0120a5a17e4b970bMay I put the record straight? Esperanto intends to be an auxiliary language, or a second language for all. Please see http://www.lernu.net for confirmation.

  • http://Anonymousnoreply@blogger.com Anonymous

    For all the blatant and clearly non-sensible self-promotion of the gold industry, one would think the gold-bugs should have driven gold up to this level long ago. It's a bubble, gold, regardless who is telling anyone -what- these days.So, other than the gold deceit, is anyone saying -put your money into another currency? And if so, which one? Which ones?China is on the brink of another cultural revolution.Europe is imploding on and off the continent.One can look around and see a lot of really tempting ideas, but that's what a kid sees when he goes to the county fair too.Throw your hoops, kids.

  • http://www.blogger.com/profile/08454222098667643650 Tom Hickey

    According to modern monetary theory (see Bill Mitchell at billyblog), in a fiat system sovereign governments have a monopoly over provisioning their own currency. As a result, only governments can increase or decrease the non-governmental net financial assets of their respective economies, e.g., by spending or taxation. Since there is no issuer of an international currency (disregarding SDR's for a moment), world trade depends in the issuer of the world's reserve currency to run constant deficits in order to supply the needed currency for world trade. The US is getting tapped out in that role of the world's marketplace of last resort and is seeking to devalue its currency to compete in exports and improve its balance. Some experts are estimating that over time, the US would like to devalue by about 30%. Emerging market mercantilism is not working and has to be fixed either by floating rates or dollar devaluation. Since the emerging world is still pegging to the dollar, the dollar must be devalued. (The danger here is a race to the bottom, since no one is able to pick up the US role as world consumer.) As a result, there is a move afoot for the increased use of SDR's to take the pressure off the US dollar and take up the slack in world trade as the restructuring takes place. The days of debt capitalism in the US financing world trade are over. The US consumer is tapped out. This is going to have major implications going forward. The US wants to get aback in the export game instead of being the world's importer.US backing for world currency stuns markets

  • http://Anonymousnoreply@blogger.com Anonymous

    i just wanna see wall street types flinging themselves from the 87th floor after they have lost everything.that would be schweeeeeeeeeeeeeeet to see.

  • http://twitter.com/gold_tracker Hal (GT)

    As Peter Grandich as said, the dollar is walking dead. But boy, Gold is shinning like crazy. Silver following suit. I’m tracking the precious metals with the free widget ExactPrice and man to see the action today was something. Right now gold is $1,042.70.The Arab states are now coming out and claiming that they were not in talks to tank the dollar so the spin is beginning. My opinion is that the info leaked out and they are trying to get ahead of it because they didn’t want gold to jump so quickly. Particularly China.

  • http://www.blogger.com/profile/15258376626576041549 atheo

    The biggest mistake being made by those that are faithful to Fisk is thinking that the currency of transaction in oil sales is relevant to what the reserve composition is in those nations. Remittances can be and are converted into whatever currencies those nations choose to hold, in other words it is their choice of investment not the currency that they are paid in that matters.Fisk's theatrics aside, the dollar is threatened not by a "cabal" of oil exporters but by the US financial industry's criminality.

  • http://www.blogger.com/profile/08454222098667643650 Tom Hickey
  • http://Anonymousnoreply@blogger.com Anonymous

    Buy Brazilian REAL currency and invest in PETROBRÁS – a Brazilian Crude Oil Producer – Brazil is to become another big OIL EXPORTER soon, very soon.

 

 

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