Why the US dollar fell during current global crises

I wouldn't say that it is a sign than consumers have lost confidence in the currency.

Shaan Saeed April 19, 2011
An interesting aspect of the Libyan, Tunisian and Japanese crises was that the US dollar fell against other major currencies, by a lot.

Normally, in times of crises, investors tend to move towards the dollar. It is viewed as a safe haven. However, during the current crises, the dollar fell to historic lows against the yen, before the massive international central-bank intervention reversed the fall (now, the financial market will remain uncertain in the next two years. You can bet on that).

Even the Euro strengthened against the dollar and Europe is considered to be in a messy situation that needs financial discipline.

The Dollar Index, which weighs the dollar against a basket of foreign currencies, fell to 75 from 80 in January, 2011. This may not seem like a big change, but in the currency markets, these changes are pretty dramatic.

Decreasing investor confidence

I wouldn't say that this fall is the beginning of the end for the dollar but it is certainly another sign of the increasing lack of confidence in the currency as a safe haven. Investors are moving into real assets such as gold and silver and taking long positions in agricultural commodities like wheat, corn, soybean, rice and sugar to protect their wealth as they navigate through tumultuous times.

This change in psychology will be critical for foreign investors in the future as inflation continues to move higher (to around 5-7 per cent according to Sam Zell, the Real Estate billionaire), and begins to more seriously affect foreign interest in US bonds, and ultimately stocks as well (stocks might take a 30 per cent plunge going forward).

If foreign investors start decreasing their massive support for US stock and bond markets, both the dollar and those markets will begin to suffer an irreversible decline (however in the short term, I think the dollar is a bit oversold and will likely rebound somewhat in the near future).

There are multiple reasons for a fall in a currency. It is not all due growing lack of confidence in the dollar. You cannot ignore the growing sense within foreign investors that the financial condition of the US government is weakening.

US planning its own fall

It is front page news that the US has too much debt and is doing little about it. In fact, it is only adding to it at increasing rates. Even worse is that the US is making it easier to add debt through either printing massive amounts of money, quantitative easing, monetary accommodation, interest rate stabilisation, balance sheet expansion or the QE3 program.

Two of the most important indicators of whether the dollar will do well, are foreign inflows of capital into the US bond and the stock market. By monitoring the changes in the remainder of the year, you will have a better idea for whether foreign investors are getting increasingly nervous about the dollar or not. The Municipal bond due payment is currently around $135 billion. These kinds of changes do not happen quickly, but when they do, they are hard to reverse.

‘If the US defaults on its debt it would be catastrophic’

According to JP Morgan Chase and Co CEO Jamie Dimon, companies, insurance funds and investors would lose access to the markets if the US appears to be heading towards a default related to its debt limit.
“If the United States actually defaults on our debt it would be catastrophic” Dimon said while addressing the US Chamber of Commerce event in Washington. Asked further what may happen if the US fails to increase its $14.29 trillion debt limit, he said “companies like us, every single company with treasuries, every insurance fund, every requirement, will start snowballing. All short-term financing would disappear.”

US Senator Marco Rubio, a Florida Republican, has said he will not approve a debt-limit increase without a range of tax-and-spending reforms. Moreover, he said the US needs to use the debt limit itself as the way to ensure that America’s debt limit begins to decline, not always go up.
“How about the debt limit starting to go down? These are the kinds of things that I hope will be focused on.”

US debt is expected to touch $19 trillion in the next 4 years.

Treasury Secretary Timothy F Geithner has said the nation will suffer “catastrophic damage” if it loses investors’ confidence. He also has said it would be “unworkable” to give priority to payments on the national debt over other government obligations.
WRITTEN BY:
Shaan Saeed A financial analyst who blogs a economisthan.blogspot.com. Saeed graduated from University of Chicago's Booth School of Business.
The views expressed by the writer and the reader comments do not necassarily reflect the views and policies of the Express Tribune.

COMMENTS (14)

Farooq | 10 years ago | Reply Great article, please keep them coming!
Shan Saeed | 10 years ago | Reply Tony, I wrote this piece in Febraury on my blog at www.economistshan.blogspot.com Tuesday, February 22, 2011 WHY YOU NEED TO BE BULLISH ON SILVER? By Shan Saeed Silver has had an incredible run over the past year or so... Where do you think it's headed in 2011? Might touch $49/ounce Silver has definitely been very exciting. The price has basically more than doubled [ 83% in 2010] and many of the stocks have done much better than that... Silver has already touched $33/ounce [first in 31 years] on 21 Feb, 2011. Its in backwardation phase, which is common in commodities but rare in precious metals. But its happening...... [what’s Backwardation: When spot price is higher than future price] So you could be forgiven for asking how long that can continue. I think the bullish case for silver going forward comes down to three main factors. FIRST is industrial demand. Everyone knows industrial use is much greater for silver than gold, and that does make it more susceptible to an economic slowdown. But what's interesting is these industrial uses are growing rapidly. But this silver investment could be one of the cheapest ways to protect your money from the decline of the U.S. dollar. For example, all of the following uses for silver are increasing: medical, apple i-phone, plasma tv, electronics, food processing, water treatment, paper,building materials, wood preservation, textiles, consumer products... the list goes on and on. Every bandage-maker, for example, now offers a silver-based product. You can buy silver-laced toothbrushes, hairbrushes, combs, and make-up applicators. In England, you can buy silver-based soap. The takeaway is that all these uses are on the rise, so even in an economic slowdown, there is a higher level of base demand. The demand for any individual application could decline, but the total number of applications for silver is increasing. Over time, I think we'll see increasing levels of demand. SECOND major factor is investment demand. Investment demand is soaring and can't be ignored. The U.S. mint sold more one-ounce Silver Eagles in January than in any other month since they began creating them in 1986. China's net imports of silver quadrupled in 2010. Against all this you have the fact that most Americans don't own any gold or especially silver. So even though there's already incredible investment demand, the potential for it to increase is still tremendous. THIRD factor is supply. Ask yourself what's wrong with this picture: Total global demand for silver is about 897 million ounces a year. Total global supply is about 729 million ounces a year. Sources: Deutsche Bank Credit Suisse JP Morgan Goldman Sachs UBS HSBC Citibank Nomura ICBC China Construction Bank Scrap currently makes up the difference, but I think the crucial point to recognize is that producers can't dig up enough silver to meet current demand. So what happens if industrial uses continue to rise? What happens if investment demand continues growing? What happens if we do get some type of currency collapse? Vietnam has already devalued its currency Dong [ 8.5%] on 20th Feb-2011 to boost exports, which is not the solution to her problem. Moody’s downgraded Vietnam and Japan in recent reports. More to come from advance economies whose policy makers are still in the reactive mood. Europe is shivering with fiscal profligacy. There were few bottleneck issues with physical supply in 2008, where mints across the world couldn't keep up with orders. A lot of it was due to them being unprepared for the rush, and they've since improved some of their operations. That's great. But even with all the improvements, even after adding equipment, even after adding staff, even after adding work shifts... they're still having issues. Over the past three or four months we've been hearing about mints having delays, temporarily running out of stock, etc. So it's still a problem. And if all the factors I just mentioned come into play, then I think you could say "bottleneck, meet desperation." Regardless of how well prepared a manufacturer might be, demand at some point could legitimately overwhelm the system, and I think that's a very real possibility. Anything could happen. But the scary thing is, we may not have enough supply to meet demand if we get a mania. So based on these factors, my view is that silver can continue rising for quite some time. I don't think it stops until SLV, the silver ETF, is a favorite of the fund managers... until Silver Wheaton is a market darling of the masses... until Pan American Silver is Wall Street's top pick for the year... That's when I'll be looking for the end of this silver bull market. Many people don't realize this, but silver rose 3,647% in the 1970s, from its November '71 low to its January 1980 high. If you were to apply the same percentage rise to our current bull market, silver would climb another 500% from here, and the price would hit $160 an ounce. Those are just numbers, but it shows that we have an established precedent for the price to go much higher. It's the fundamentals, of course, that will determine how high the price ultimately goes. Show me a healthy dollar, show me no threat of inflation, show me a responsible government that stops printing money... Show me a repentant Iran and North Korea...Show me that Middle East is at peace with rulers[ Jordan, Egypt, Tunisia, Bahrain, Morocco, Saudi Arabia, Kuwait] acting normally and not running from the country. Show me that the sovereign debt issues in Europe are resolved... Show me positive real interest rates... Show me that unemployment is plummeting, that bank closures have stopped, that real estate is recovering...Show me all that and I'll talk about the gold and silver run being over... But until those things start changing in a big way, I'm still buying. Silver bears often suggest that a large part of the rally in the last bull market was due to the Hunt brothers, who were accused of trying to corner the market. What is my take on that? I'm skeptical that the reason silver went as high as it did was primarily due to the Hunt brothers' activity in the market. It's interesting to note that they bought silver primarily because they mistrusted the government, and because they thought silver was going to be confiscated. Remember... gold ownership was illegal when they first started buying silver in the early '70s. Yes, they [ Hunt brother] bought a lot of silver... But if you look at the correlation, you'll notice the price didn't necessarily move up when they bought. In fact, when the rumors that they were trying to "corner" the silver market really started going mainstream, which was in the spring of 1974, the silver price dropped solidly for the next two years. One would think that the price would've risen not fallen if silver was being "cornered." Secondly, if you look at price charts, silver moved in lockstep with gold back then. They rose and fell pretty much together. They both peaked on the very same day, January 21, 1980. So unless the gold market was equally spooked by what the Hunt brothers were doing with silver, it seems a stretch to assume they were the primary cause of the rise. Lastly, you have to consider that it was the mainstream media that largely promoted this idea the Hunts were "cornering" the market. With that in mind, one has to be suspicious that was, in fact, the case. To be clear, I'm sure they had some effect, but to suggest they were the main impetus behind silver's tremendous rise doesn't seem wholly accurate. And look at the price today... It's outperforming gold in our current bull market, just as it did in the '70s, and there's no Nelson Bunker Hunt around. Besides... who's to say that we won't see other "Hunts" come along today and try to buy up large quantities of the metal? I wouldn't rule it out. So again, I think it's more important to look at silver's fundamentals for any kind of price projection than a one-off event. And those fundamentals are very bullish. ECONOMIC CRASH I elaborated this earlier... but if the economy crashes, silver is likely to suffer more than gold due to its large industrial use component. Another factor is that silver is not bought by central banks, so one source of demand for gold is not present with silver. But I think the bigger trend of a currency crisis is going to dwarf those concerns. I see lot of currency intervention in the global financial markets. Chinese yuan would be under pressure from USA. However, Yuan/Renminbi would appreciate 4-5% in 2011 against US dollar with GDP touching 9.6% Prudent approach Silver is more volatile than gold, but that just means you get better opportunities to buy it cheaper, and probably make more money on it if you sell near the top. So yes, there are bearish arguments for silver, and one has to be prudent in buying it – you don't want it to be the only asset you own, for example. But it would be equally a mistake to not own a meaningful amount. Good time to buy… There's your answer. If you have minimal or no exposure, I suggest buying. Don't rush out and spend all your available cash, because there will always be corrections, but the less you own, the more you want to make a plan to add a meaningful amount to your portfolio. Remember...silver is a currency replacement just like gold. It's money... and therefore you want to make sure you own enough for both protection and profit. If you don't own enough, I suggest going into "accumulation" mode... buying some on a regular basis, like dollar-cost averaging. My recommendation which is a conservative by the way – is that approximately one-third of your strategic valued assets be devoted to the precious metals market. That includes gold, silver, and precious metal stocks. That may sound extreme to some, but I think the risk to currencies right now is extreme. Chinese government has already communicated to her people to increase their Gold and Silver holding in their asset portfolios. Therefore, being overweight precious metals is justified. Obviously, each individual investor has to be comfortable with what they do. I generally recommend you hold more gold than silver. I suggest approximately 70%-80% in gold versus 20%-30% in silver. Depending on your situation and risk tolerance, you may wish to have more or less in silver, but again the point is to have meaningful or market focused exposure. Silver purchased method: The options are becoming more and more mainstream, so it's getting easier to buy both metals. The alternatives are growing, and they're also improving. You basically have two choices: You can either buy and store it yourself, or you can buy and have someone else store it for you. Ideally, you want to do both... you want to DIVERSIFY YOUR RISK AND ASSET CLASS. There are risks to storing metals yourself, such as theft, loss, or fire. You can put it in a safe deposit box, but then it's in the financial system and it's subject to banking hours and could even be susceptible to confiscation, though I'm skeptical that will actually happen. But I do think everyone should have some physical silver handy, at least a couple months worth of expenses. So the short answer is to diversify what you buy and how you store it. For physical silver, I would stick to buying the popular one-ounce bullion coins – Eagles, Maple Leafs, etc. Silver Stocks. It's pretty clear the go-to stock in the silver industry – in my opinion at least – is Silver Wheaton. It's definitely been a sweetheart the past two years. It's given us everything we could want in a silver stock. The stock suffered badly in the meltdown of '08, and things did get a little dicey at the time, but I remember thinking that unless the world comes to an end and the silver price never recovers, this company is going to survive and bounce back – in part because of management and in part because of the business model. They have no exposure to mining costs, for example. Shares back then were around $3... If you bought at the time, they're now a ten-bagger. So it's been an incredible run. The question, of course, is going forward: Since the stock is already at $35, can it be another ten-bagger from here? The company expects to increase "production" by 70% by 2013. And their costs will basically stay stagnant. Meanwhile, imagine where the silver price could be in the next two to three years, and you can see this company can make enormous amounts of cash. Some of that is probably priced into the stock already, but you can't deny where this company is headed over the next few years. Could it have a big correction? Recently dropped as much as 28%, but sure... it could easily fall more than that in a major correction. But if that happened, I'd consider it a big buying opportunity. In my opinion, the bigger the correction, the bigger the buying opportunity, because I really believe the future is very bright for the company. NUTSHELL If you're bullish on gold, I think you need to be bullish on silver, unless you think inflation will never come to pass. Regardless of the short-term fluctuations in the market, it's only a matter of time before the currency issues punch us in the gut and inflation really takes off. Second, remember that silver will be volatile, but focus on the fundamentals and use sell offs as buying opportunities. Until the fundamentals driving the bull market change, buy. Bottom line, the bull market is far from over. I think it's going to go much longer and much stronger... So buying on dips is the best advice I could give anyone.
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