As Currencies Collapse, What Do You Do?
"By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens."
-- John Maynard Keynes
For the record, I believe John Maynard Keynes is one of the top-ten most evil human beings ever to have walked the earth, but I am thrilled to see that he at least admitted his theories amount to no more than legalized theft. And I know many of you will point out that I have used this quote several times in the last year. It may trouble you to know I’ll probably continue to use it now and then, just to remind the Keynesians of the world that even the author of the theories they hold so dear considered them to be immoral. Of course, I’m presuming Keynes believed theft is immoral. I never spoke to him. So I can’t say for sure.
In the last several trading days, I've been watching the dollar strengthen, which, if you've been reading my articles, doesn't make a lot of sense -- at least not on the surface. The Fed (and every other major central bank) is creating currency and easing credit more than ever in history, and that, by definition, is inflationary. Remember what I’ve said so many times: inflation is not defined as rising prices; inflation is an increase in the amount of currency and credit available. Rising prices result from inflation. So if there are more dollars in the economy right now than ever before in history, shouldn't prices be rising? Further, as long-term Treasury yields increase -- as they have been over the last year -- doesn't this offer further evidence that rates are on an upward trend? And if they are going higher, as the cost of borrowing increases, won’t that cause hurdle rates to move higher, as well? (A hurdle rate is the rate at which managers and/or investors decide for or against an investment. If, for example, the hurdle rate is 12%, then any projected rate of return below 12% is rejected as an investment.)
But the dollar is stronger for now, and below is a video analysis of a chart that bears out yet more possible gains from the greenback – at least in the short term. The chart also serves as a good example of why I am not a technician, and why I don't use charts for anything but confirmation of trends. Nonetheless, it’s a solid counterargument, so I thought I’d at least include it:
It seems to me, however, as though there are two very strong long-term forces threatening to send rates and prices higher:
1. Unprecedented printing and easing of credit.
2. A diminishing appetite for U.S. debt.
Let me ask you this: would you loan money to any entity at less than 5%, knowing the entity’s credit was bumping against its ceiling, and that its earning-power had been severely crippled? I know I wouldn't. But somebody has been buying Treasuries, and I think those "somebodies" are starting to realize just exactly how stupid that sort of behavior is.
Consider these comments Friday, 12/18/09, from Zhu Min, deputy governor of the People's Bank of China:
“The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible.”
"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries."
What if sovereign nations are slowly beginning to curtail their purchases of U.S. Treasuries? Might that not account for the rise we’ve seen in yields over the last year? “Man-of-the-year” Bernanke says he’s going to hold down the long-end of the yield curve, but that hasn’t been working so well for him; it’s hard to keep rates down when the global economy no longer wants your debt.
But let’s take it a step further: what if, say China, suddenly noticed that the U.S. government really isn’t all that credit worthy anymore. And what if about a year ago, China recognized that long-end prices were at historical highs, and yields were at historical lows. What would China likely do? Right. They’d slowly start selling – or at least start minimizing purchases. And what would happen to bond prices? They’d fall. And how about those yields? Yep. They’d start creeping up.
I know what you’re going to say: foreign nations hold only a relatively small percentage of U.S. debt. So what? That certainly doesn’t mean foreign nations are the only investors in the world who recognize what is happening to United States credit. Treasuries are not the safe-haven they once were. More often than not these days, they move in tandem with the stock market! What kind of behavior is that for the so-called “risk free rate of return?”
Here’s the part most people don’t think about, however: if foreigners are slowly cashing in U.S. bonds, what happens? Effectively, they sell bonds, and they buy dollars. And until they convert those dollars to some other asset – whether a currency or some commodity – the dollar will strengthen. But how long with these foreigners hold on to greenbacks? My guess is not long, and I’m willing to bet the recent dollar rally is going to be very ephemeral.
Just as investors have started to realize that Treasury yields and prices are unsustainable at these levels, they will soon realize that the dollar is no longer the store of value it once was either. It cannot sustain its status as the world’s currency reserve. With the massive amounts of debt the U.S. has piled up, along with the unprecedented number of dollars now printed and floating in the system, public perception of the dollar is about to change. And there may be one more surprise coming that most people aren't anticipating: it is very likely that many of the world's largest oil-producing countries may soon begin transacting in some currency other than the dollar.
WHERE TO INVEST NOW?
Stocks? I continue to say absolutely not.
For over a year, I've argued that stocks would recover, and then trade sideways to down for a very long time. I've also suggested that there is a possibility that stocks might even continue to climb, but not until inflationary price pressure begins to accelerate.
My argument is that no matter what stocks do, they will fail to outperform general price increases deriving from inflation.
Below are two technical videos (click charts to see videos) supporting my argument that the markets will trade sideways to down for a time, as prices pick up speed. The first is a video analysis of the Dow Jones Industrial Average:
So if you believe the dollar is heading south, where do you put your money? Should you short the dollar? Or perhaps you should go long the euro? I don't think either is a good investment; most currencies in the world are going to lose value as governments print their way out of this mess. Even the Swiss -- traditionally the most fiscally responsible government on earth -- are getting on board.
I think the Euro could be a moderately good short- to medium-term trade. One of the euro's strengths is that the European Union doesn't issue debt (at least for now), and so its monetary policy isn't heavily reliant on that component -- the way U.S. is. At least from the debt perspective, the euro isn’t as affected by the debt component, and so the world may well shift away from the dollar to the euro as its global currency reserve.
Or maybe the Chinese will get their wish, and SDRs will replace the dollar. Who knows? And who cares? Any fiat currency that replaces the dollar is going to have just as many problems. Remember the European Union's currency printing presses are in high gear too – along with everyone else’s. The only thing that’s going to stop the pattern of violent economic gyrations we’ve seen in the last century is the decriminalization of private competing currencies, backed by commodities – most likely precious metals.
So if all fiat currencies are going to fall simultaneously, what will they be falling in relation to?
The answer to that is simple: commodities. And that's where I’m putting my money. I still believe energy, agriculture, and metals are going to be sure winners; I’m especially bullish on silver right now, but when inflation really starts to hand us higher dollar-based prices, I think investor psychology will head toward gold because it is by far perceived as the most stable, long-term store of value in the world -- as it has been for thousands of years.
There are some people who believe gold and oil are going lower -- and by extension, that the dollar is going higher. I obviously disagree with that position -- as I said earlier -- before I expound, here are two bearish video counterarguments to my thoughts on gold and oil, respectively (click charts to see videos):
GOLD:
OIL:
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Disclosures:
Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.
Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com.Copyright 2009, Paco Ahlgren. All Rights Reserved.
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