Investing

THE VALUE OF THE DOLLAR & CURRENT ACCOUNT DEFICIT

Members of the Fed are already starting to talk about the value of the dollar and how it needs to fall as a result of the US trade imbalance. Many others have explained this much better than I can (Like Buffett here in http://research.stlouisfed.org/fred2/series/M3NS/24). In the end there has not been 50% more wealth created and this will have to lead to massive inflation over time. If there is 50% more money then it stands to reason that each dollar is worth 50% less. This should have translated into a 50% drop in the price of the dollar, all else being equal, but again all else is not equal. The Asian markets rely on the US to buy their goods and are lending us money to do so. Bond yields usually go up with massive inflation but they’re not this time because all of that 50% more money has to go somewhere and it has, into the bond market driving up prices and yields down.

There are effectively short, medium and long term currency trends at play here. In the short term there are traders and moves are pretty much random. In the medium term there are interest rate differences that support the carry trade, (borrowing 1M in the US at 1.5% and investing in Australia at 5%) and investment demand. In the long term, the terms of trade dictate the direction. Who know what the short term holds! In the medium term the dollar is becoming less attractive as the short currency in the carry trade, but there is still a wide spread between the US and Australian/ New Zealand rates. This spread isn’t really likely to close too much as the Fed will only tighten as the economy is improving and has stated many times that they will do so at a measured pace. I see the medium term factors as weakly bearish for the dollar. As for the long term factors the US is running a huge deficit and this has to correct with a large decrease in the dollar and while reported inflation is very low, 50% more money should mean that over time the dollar will correct in real terms and that is very bearish.

How do you play this trade?

• Buy Silver (which has fantastic supply/ demand characteristics right now; there is a supply shortage)
• Buy Gold (the world’s central banks own most of the gold and can keep a cap on its rise)
• Buy Oil (The supply/ demand characteristics are also great for oil)
• Buy any other commodity as commodities hold their real value, regardless of the currency. That is over the last 200 years, gold is worth the same today in real dollars as it was back then. Same for many commodities, bearing in mind thought, that over time technology makes commodities cheaper.
• Buy stocks in countries with better currency characteristics. The commodity currencies did incredibly well in the last commodities boom, with the Australian dollar at 90c against the USD. It’s currently at 72c. There are some excellent Australian banks with great dividends in the 6-7% region. I particularly like the British bank Lloyds TSB and an Australian bank ANZ.
• Buy foreign currency and keep them in an FDIC insured money market account with a bank like Everbank.

The dollar is at a relative high point against a number of foreign currencies right now, which provides a good (if not perfect) entry point. I have investments in Silver, Gold, Foreign Banks, I am short the 30 year treasury and long a energy company with a wordwide investment porfolio.

posted by Neil  # 4:32 PM