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The Dollar: Not Dead Yet

By Roger Conrad on January 11, 2013

I’m always suspicious of pat theories—especially when they involve economics. The larger the consensus that something is “inevitable,” the less likely it is to actually happen.

One such “sure thing” making the rounds now in the popular press concerns the US dollar. Basically, it’s taken as an article of faith by many that the greenback is destined to become worthless over the next few years.

The corollary is the US economy is headed for hyperinflation and a ruined stock market. And the prescribed course of action is often to sell anything priced in US dollars, socking the proceeds in gold bullion preferably in a vault outside the jurisdiction of Uncle Sam.

The first pillar of this theory is current US government deficits are untenable and uncontrollable. The second is the Federal Reserve’s quantitative easing has dangerously inflated the money supply. If anything, the sentiment of inevitability is stronger than ever, now that President Obama has been re-elected for another four years and Fed Chairman Ben Bernanke’s job is safe.

To be sure, Uncle Sam is running up red ink at an unsustainable pace. The cost of the social safety net is rising along with the aging of the population. Interest costs are surging as the debt grows, despite record low Treasury bond yields. In fact, “real” or inflation-adjusted interest rates are either at zero or negative, depending on how you measure prices.

Moreover, the current pace of economic growth is hardly encouraging for growing out of deficits. And Republicans and Democrats are still as much at loggerheads as ever, with an evident shortage of real dealmakers.

Unlike in years past, Congressmen spend less time in Washington and more of it at home raising campaign money from constituents. That leaves less time to get to know the opposition as fellow human beings, which in turn makes it more difficult to do the deals that are necessary for democracy to function.

Brave New World

As for monetary policy, we are truly in uncharted territory. The Bernanke Fed has done pretty much the opposite of what the central bank did during in the 1930s, the last sizeable period of US deflationary pressures.

Following the 1929 crash, the Federal Reserve did not loosen up the money supply. Rather, it followed past practice of allowing the market and economy to find a bottom on their own. The result was banks failed, credit dried up and the economy contracted radically as unemployment soared.

If took several years for conditions to truly stabilize and start to improve. Commodity prices—the real canary in the coal mine when it comes to economic growth—didn’t start rising until mid-decade.

This time around, the Fed acted immediately to prop up failing banks and restore confidence. That prevented a repeat of the bank runs that wiped out depositors at the start of the Depression.

Despite the Fed’s open window, credit markets did freeze up and many companies failed. The US economy went into sharp reverse shrinking nearly 9 percent in back-to-back quarters and the stock market kept falling until March 2009.

But in sharp contrast to the 1930s, commodity prices responded almost immediately, with oil actually bottoming in late 2008, just weeks after the crash. By the end of 2009, the stock market was well on its way back, the economy was inching along again and unemployment had peaked.

All of those are sharp differences with what happened after the Crash of 1929. The primary reason is an extremely expansionary fiscal policy constructed by a student of the Depression (Bernanke) that’s 180 degrees opposite from what the 1930s Fed did.

A Switch In Time

We’re now in a place we’ve never been in before. But the Fed is clear that it intends to maintain quantitative easing until the economy is fired up again, and that its gauge of that will be a drop in the unemployment rate.

Maintaining expansionary monetary policy when growth is firing up has historically been a sure fire formula for faster inflation. President Jimmy Carter discovered that painful reality when his first Fed Chairman C. Arthur Burns spurred money growth in the late 1970s to advance the goal of full employment, spurring sharply higher inflation.

Consequently, the trick at some point will be a timely switch by the Fed from expansion to a neutral monetary policy, and later to a tighter one. If the history of past Fed actions is any guide, there will almost certainly be bumps.

However, despite all the gnashing of teeth about inevitable dollar disaster, market action has been saying something completely different. For one thing, the US dollar is actually at a higher level against the Euro than it was when the Fed bailed out the banks and launched its easy money push in late 2008.

The buck is roughly where it was against the Japanese yen as well, and has posted sizeable gains since mid-November. And it’s even flat against the resource-weighted Canadian dollar from the day Lehman Brothers vanished in September 2008.

As far as I’m concerned, Chuck Butler of Everbank gets credit for the best quote on currency markets I’ve heard—mainly that they’re in an “ugly contest” as governments all over the world print money to fight unemployment. That’s likely to be the case for some time, although stronger fiscal positions and commodity exports should boost the Canadian and Australian dollars over time.

However, for a US dollar crash to occur, the greenback must have something to crash against. To date at least, that hasn’t happened in the currency markets. In fact, as reported in your Wall Street Journal this week, the dollar has actually rallied since the beginning of the year.

That’s the first time in a very long while the US dollar has done anything positive when the market has become more hopeful about the global economy. The likely catalyst—Washington’s January deal on taxes—could prove fleeting, particularly if politicians go down to the wire before reaching a deal on government spending and raising the federal debt ceiling.

But for now, the US dollar has rallied for some other reason than bad news. And that’s very promising for its ability to hold value when the global economy does finally start to pick up steam.

Glittering Less

Gold is one market that has rallied strongly against the US dollar since the 2008 crash. The yellow metal struck a low of $660 an ounce in late October 2008 and by September 6, 2011 had nearly tripled to a high of around $1,860. Since then, however, the action has been flat to down trending, with the precious metal hovering around $1,620 this week.

I remain an advocate of holding some gold. And despite their generally disappointing performance in 2012, we continue to recommend mining stocks and funds in the Personal Finance model portfolios. The metal itself would have to reach at least $3,000 an ounce to hit a new inflation-adjusted high.

That’s a lot of potential upside for gold if inflation really did cut loose as it did in the 1970s. And because none of us have a crystal ball, that’s a possibility worth protecting against.

But we’re nowhere close to that kind of rapid inflation now. Until we really do see some upward movement in wages, the most we’re going to get is what’s triggered by commodity price increases, which if anything is contractionary because it takes money out of Americans’ pockets.

The Oil Factor

One final point dollar bears may want to consider. Based on current development rates from shale discoveries in the Bakken (upper Midwest) and Eagle Ford (west Texas), by 2020 the US will overtake Saudi Arabia as the world’s biggest oil producer.

It may take a bit longer than that to produce as much oil as we consume. But by then we are likely to be exporting vast amounts of natural gas, as liquefied natural gas terminals come on stream off the Atlantic, Gulf and Canadian Pacific coasts.

Back in the late 1970s, the United Kingdom got a huge lift from a vast oil discovery in the North Sea. Certainly, Margaret Thatcher proved far more favorable to investment than the previous ineffective Labour government. But producing record amounts of oil made the pound a petro currency for a time, strengthening on the world stage as oil edged higher.

Again, I’m skeptical of all pat theories, including this one. But if the US were to become a major exporter of energy in coming years, it would be a major pillar of strength for the US dollar—and a big nail in the coffin for dollar doomsday theorists.

My point is simply this. No economic theory is infallible and nothing regarding the US dollar—or any other investment market—is inevitable.

Being a successful investor doesn’t depend on subscribing to the right economic theory. The more you tie your investments to one, the more likely you are to go broke.

Rather, the key is building a diversified and balanced portfolio with good investments that can weather the bad times and will gain value over time. Hold some gold and by all means stocks priced in foreign currency. But have some first-rate US companies in your pocket, too. America does, after all, still boast some of the worlds’ finest.

If you’re an income investor, you should choose stocks, bonds, mutual funds and other positions that pay dividends. If you’re not, I still recommend watching dividends as an outward sign of inner grace, but focusing more on dividend growth than absolute yield.

Whatever your fancy, you’ll do best by sticking to what’s happening on the ground. The air from 30,000 feet is just too easy to cloud up with hyperbole and economic theories that rarely if ever stand the test of simple human interaction.



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  1. avatar
    Luis de Agustin Reply January 13, 2013 at 2:05 PM EDT

    For those who want an alternative to gold, a thought.

    By spring 2011, US and Canadian stock markets regained equally from the 2008-09 crash. However, Canada’s fell back some while the US market continued gains.

    Their five years annualized returns: .5% US, minus 1.8% Canada. Yet, a 15-year perspective identifies: 4.8% US, 9.7% Canada. Why? And how does the answer better potentially position investors profitably?

    Wainwright Economics’ December 2012 report: US and Canada stocks, a triangular correlation with gold, explains economic reasons for the relative performance of the two equity markets to vary so much over time. To be sure, economic policies differ, but part of the answer, finds Wainwright, lies in Canada’s industry mix – much more tilted to natural resources, and thus tending to be pro-inflationary and more cyclical than the US.

    Wainwright’s analysis led by David Ranson, president and head of research, precisely constructs the economic circumstances between the two markets and their asset natures. Additionally, the work attests to the use of “polar opposite” asset choices as are US stocks and gold, and how market conditions can favor Canadian stocks over US, i.e. Canadian stocks showing up as a “gold like” asset form a US investor’s point of view.

    For investors seeing low-growth / high inflation conditions ahead who can’t bring themselves or are not permitted to take a significant gold position, the Canadian stock market because it resembles gold under such conditions, provides according to Wainwright, a most advantageous place to shine free of the accursed “gold investor” attribution.

    Luis de Agustin

  2. avatar
    lee ramsauer Reply January 12, 2013 at 12:42 PM EDT

    Since the fed is buying most of the treasury debt, perhaps at some point the fed and the treasury will agree that the fed will simply tear up it’s holdings of debt and thereby reduce the total debt outstanding. Of course, the reserves held by the major banks at the fed, from the fed buying the treasuries from the banks, would have to be reclassified/confiscated/eliminated; since the banks are virtually minions of government policy, surely a way can be found.