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Why the US dollar fell during current global crises

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 | 13 years ago | Reply Great article, please keep them coming!

Shan Saeed | 13 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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Tony Singh | 13 years ago | Reply @Ashutosh: Thanks to you too. Now have a better prospective. Now waiting for a blog shedding some light on Gold and specially Silver prices. (not with the argument that its hedge against the weak economy or CHinese/Indian/ world central bank demands. (Somehow that argument is not very convincing). Looking for someone who can give fresh insight - specially on Silver) Thanks again

Sarmayakar | 13 years ago | Reply For proper understanding of our capital there is need to provide information in vernacular language so that people could understand how money supply impact prices and how foreign exchange influences the rupee against dollar. For the one may visit www.sarmayakar.com where all such information is easily available in Urdu language..

Ashutosh | 13 years ago | Reply @Tony Singh: Your point no. 1) Mostly, US is a consumption driven economy. Also the are the largest investor (US outbound) in the world. So, traditionally a strong Dollar policy had been followed by US to import cheap and invest overseas cheap. This is unlike most other nation in the world, who will like to follow weak-currency policy as it makes exports competitive and also acts as a barrier against imports. Deliberate attempt to weaken Dollar by the US, though seems logical yet may only be speculative. Also lets not forget, that the Fed had joined other central banks around the globe to arrest the fall of Dollar by intervening in the forex market. Yours 2). Exports to US from China or Japan will become expensive and we may see some fall in exports from these countries. However, this may lead to inflation too. If China/ Japan feel threatened by the falling value of their securities, then they can sell them off and look for investment in other currencies like the Euros or Yen or Pound or Swiss Frank and even Bullion and other commodities. Yours 2a) "allow this to happen" ..uh! The forex market is a extremely huge market and extremely liquid too. Many central banks around the globe keep intervening it the market to protect their currency. China, Japan and other nations can at best be expected to intervene selling their own currency (there by creating a huge supply) and buying Dollar (reducing the availability of Dollar) thus supporting Dollar. This mostly works well. However, there are incidences that all of them combined too had lost to the power of markets in the past. Yours 2b) Price is an interesting thing in a market. Many people will give you many theories regarding the price, but can anyone forecast(?) is doubtful. To me it is all about increase or decrease in demand and supply. If people and government buy Dollar in spite of a weak economic situation in US, the value of Dollar is unlikely to fall. However, if people looses confidence in Dollar, then ...uh ! Yours 3) US economy is very different from any country of the world. When any country imports then the importer has to buy Dollar and the exporter will sell them against own currency (adding to the Dollar reserves) or may keep Dollars for future use. However, in case of US imports, the payment is made out of own currency. It is like importing and giving printed papers in return. Since this notes do not always come back to US monitory or financial systems, as they are held by corporates/ non-corporates/ governments elsewhere so, they do not necessarily lead to inflation is US. This also acts as a major incentive for US to follow expensive Dollar policy so that they have to pay (print) less Dollars for more goods and services.

Tony Singh | 13 years ago | Reply Thanks Mr. Shaan Saeed. At least now I got a vague idea on mechanics of world economy. Its indeed interesting. Thanks again.

Moise | 13 years ago | Reply All paper currencies die. All interest based systems run aground. This is how financial oligarchs fleece the people couple with inflation, taxes, devaluation, bailouts. There is a reason why interest is explicitly forbidden in Islam and the sole reason there is clash of civilizations. While we swim in new jargons like POMOs & QEs the modus operandi of robbing people of their wealth goes back to antiquity.

Shan Saeed | 13 years ago | Reply Tony to answer your question 1. QE2 [ printing money] is a deliberate attempt to debase the US dollar to increase exports. Its a tactical manueruing not sustainable for the long run. Plus extra dollars that they are printing are going to emerging markets to create bubble in the equity, real estate and bond markets. China is mving away from US dollar although she does hold $3 trillion in reserves. China and Japan are buying Gold and silver to diversify their reserves. I m bullish on Chinese yuan /renminbi. China is trading with Russia, Korea, Malaysia in their own currencies. This is hurting the US dollar sentiments. 90% of the global trade is done in US dollar... 41 states in US are behaving like greece and portugal. S&P has down grade the rating from stable to negative. Gove you an idea whats going on in USA. Bail out is not the solution neither in Europe nor in USA. Restructuring of loans is the solution and economically practical. Please follow my blog at www.economistshan.blogspot.com to gt global economic insight...

Tony Singh | 13 years ago | Reply Friends I am not good at this . So enlighten me 1. What happens if the US deliberately lets the dollar fall inorder to make its goods cheaper in International market ( A possibility?) 2. How does it effect China and Japan (The two largest holders of American securities). a) Can these countries allow this to happen? b) How can they stop this from happening if there is indeed an inherent weakness in US economy? What will be the impact on Global economy as a whole? 3. How is the state of US economy any different from say Greece, Ireland or Portugal ? (All have gone to IMF/World bank for debt restructuring) Can anybody throw light on these?

parvez | 13 years ago | Reply For the small man all this really adds up to is interesting reading and an exercise to try and fathom a subject that even the experts find difficult. After reading ' Too Big to Fail ' and then watching the documentary ' Inside Job ' (great editing) one does get the heebee-jeebees and you can fantasises that if greed and financial engineering can do that, then what else can it do if applied on a global scale between countries.

Ozair Ali | 13 years ago | Reply I think the US is more scared of a Japan-like deflation and stagnation of the economy in the short-run. They're ready to take a hit on the dollar in the short and medium run. And I agree with you when you say that the problem is less of the staggering debt and more of investor's confidence in America's ability to pay back, or at least rollover, the debt. The country is just too big to fail.

Fahad Raza | 13 years ago | Reply What a Gem of an article!... I just can't get why the GOP is being held up accountable by american people in general for giving billionaires tax cuts of nearly 600 million ? As Warren Buffet pointed out war on middle class will be imposed, this sure looks to be true.

TightDhoti | 13 years ago | Reply Time to stock up on gold! :) If you can afford to do so that is.

alpha gamma | 13 years ago | Reply I was discussing exactly the same thing with some friends the other day....your article is interesting and to the point

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