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Imagine that you have $2.8 trillion sitting around. And for kicks, let’s assume that most of that money, about two-thirds, is invested in U.S. dollars and other dollar-denominated assets like U.S. Treasury bonds.
And let’s assume that your currency was linked to the U.S. dollar, too. In other words, you often buy dollars to maintain a stable value relative to the buck.
As long as the dollar is doing okay, there’s no problem. But what if it’s falling, as it has been over the last few years?
You might decide to no longer peg your currency to the dollar. That solves the problem of tying your monetary policy to a boulder rolling downhill.
Of course, your decision also means your $2.8 trillion in dollar-denominated assets will get hammered in the process!
Okay, you say, I can just sell off a lot of those assets to avoid the losses. The problem is that it’s not easy to unload such a huge amount of investments without the market realizing what you’re doing. And when they catch wind of your plan, they’ll sell too. Thus, the price will fall even faster!
It’s a real Catch 22. And you know what?
This Is Precisely the Situation China
And the Gulf States Find Themselves In!
Between them, China and the oil sheikdoms are sitting on an estimated $2.8 trillion in reserves; thanks to huge trade surpluses and massive oil revenues.
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And not only are their currencies pegged to the dollar, but they also both have a large dependence on the U.S. economy.
China doesn’t want to kill the U.S. consumer. That would hurt its export growth, which is still the primary driver of the Chinese economy.
Meanwhile, the Gulf States — OPEC rhetoric aside — understand that any global financial turmoil created from a falling dollar will hurt their own investments and could mean lower (and thus lower prices) for crude oil.
So, here’s the $2.8 trillion question: Will the Big Dog among the Gulf States (Saudi Arabia) and the Big Dog on the global economic stage (China) completely abandon the dollar?
I don’t think so.
They have more to lose than gain if they cut their ties to the buck. It’s simple self-interest! And I believe the U.S. Fed and Treasury know this. In fact, I believe they have an implicit policy in place to placate these Big Dogs. I’ll get to that in a moment. First, I want to be clear on something else …
Therefore, the Dollar’s Decline Is
Not Over, It Will Just Remain Orderly!
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| The dollar’s decline is like an orderly funeral procession … |
Even if China and Saudi Arabia don’t abandon the dollar, as far as the markets are concerned, the very idea that they could is problem enough.
And until we witness a real fundamental improvement in the factors that are most important to the direction of the buck — economic growth and interest rates — these bad news scenarios will reign supreme.
You see, in the currency game, perceptions are what matter most.
So as you listen to the daily chit-chat and read the flow of news concerning the dollar, keep in mind there is a lot that goes on behind the scenes that we are not, and never will be, privy to.
The best you can do is piece together words and actions to discern implicit policy and consider all public statements by policymakers as either window dressing or efforts to subtly advance their predetermined policies.
Why on Earth Would the U.S.
Want the Dollar to Fall?
Here’s how I think the current argument goes:
The U.S. wants nothing more than to keep global growth humming …
In order for global growth to remain on track, they know that China has to keep going gangbusters …
And for China to keep thriving, they know that Mr. and Mrs. U.S. Consumer must continue shopping. That’s because they’re still the biggest buyers of China’s exports.
Thus, everything still hinges on U.S. consumers!
The Fed knows that lowering interest rates is the best way to support domestic shoppers. Lower rates make it easier for people to keep borrowing and buying.
As happy side effects, those lower interest rates also:
Make money cheaper to borrow and readily available for investment speculation.
Push the value of the dollar lower, which makes things like U.S. stocks look cheaper to foreign investors (see my chart).
Allow large multinational U.S. companies to translate foreign sales back into more dollars.
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The sum total of these three forces is that U.S. stocks are likely to go up. That’s great since higher stocks also makes U.S. shoppers feel wealthier and more likely to spend, spend, spend.
Let me explain …
We all know U.S. housing prices are falling off a cliff. That can have a major impact on consumer spending, as people who are losing money (even on paper) are less inclined to hit the mall.
BUT, if the stock market is rising and pushing up the value of just about every consumer’s 401(k), that goes a long way toward making them feel better about their spending habits.
Voila! A rising stock market is an excellent way to counter the negative wealth effect from falling housing prices.
So, you see, lower interest rates and a lower dollar go hand in hand. What’s more, they actually form a self-reinforcing cycle … precisely the kind of cycle that the U.S. wants right now.
Bottom Line: Your Money Gets Less Valuable,
But All the Big Dogs Stay Happy
China benefits as the U.S. consumer stays in the game.
Saudi Arabia benefits by selling more oil, at high prices, as global demand remains intact.
And the U.S. economy benefits as exports rise and its assets look increasingly cheap to international investors.
Who knows, one of these days, even U.S. real estate prices might look cheap to big investors holding euros, pounds, Australian or Canadian dollars.
Of course, in the meantime, the paper in your wallet will keep shrinking in value, and a lot of currencies will continue gaining against the greenback.
So the best strategy is staying on the side of the currencies that have the momentum. That’s the best way to protect yourself throughout the dollar’s orderly decline.
Best wishes,
Jack
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