John Mauldin on dollar and gold, from Millennium Wave
As I predicted several months ago, the dollar is beginning to show
signs of real weakness against the euro and a host of other
currencies. It has the potential to happen even faster than the
gradual process I originally thought it would. But what does it mean
for you and your investments? Today, we are going to look at some of
the implications of a weaker dollar, whether or not it means
inflation or, even worse, stagflation is in our future and what the
implications of a weaker dollar will mean for the Muddle Through
Economy. As promised last week, we will take a pass at what all
this means for interest rates, as well, so we have lots to think
about.
Gravity and the Dollar
As mentioned above, a few months ago I suggested the current account
deficit will take the dollar down later this year. But it seems to
be happening a little faster. What gives?
Currency moves are always part perception and part gravity. By that
I mean, currency traders are subject to what they perceive the
various governments of the world will do to protect their
currencies. If you are trading at 20 to 1 leverage, you do not want
to be on the wrong side of a currency intervention by a major
government. It can ruin your day.
There are dozens of other factors currency traders focus on, and
their perception of these facts makes for one of the most dynamic
and fluid of world markets. Perception can result in some violent
short-term movement in currency values. Perception can be like an
Olympic pole vaulter. It can be quick up and downs. Or it can be
like an airplane, and stay up for quite a while, straight and level.
But eventually gravity wins and pulls the jumper and the plane back
to earth. A government cannot artificially prop up a currency
forever beyond the long-term demand for a countries products and
services. Eventually the gravity of the marketplace will force a
currency to its correct level.
It used to be that central banks were given at least a modicum of
respect about their ability to control their currency. That changed
in 1991-92 as one currency after another came under the attack of
the world currency markets. The classic line attributed to George
Soros, who had made a large bet against the British pound, when
asked to comment upon the Bank of England preparing to spend 30
billion pounds to protect the value of the pound was, "What are they
going to do in the next 30 minutes?"
What he meant was that the Bank of England's 30 billion would last
about 30 minutes. The world currency markets are now larger than
central banks. The central banks can punish currency traders in the
short run, and that threat is taken seriously. But in the long run,
over-valued currencies will drop like a plane out of gas.
The classic acknowledgement of this was in 1992 when Walter Wriston
wrote an Op-Ed piece for the Wall Street Journal (which was
essentially a puff-piece for his book, "Twilight of Sovereignty.")
Wriston was perhaps the last major force as a banker of the last
century. He was head of Citibank, the Council on foreign Relations,
etc. When you were looking for insiders, you always found him at the
center. You couldn't get any more inside than Wriston.
That editorial made as much of an impression on me as any one piece
I can remember. Basically, this insider waved the white flag and
said to his cohorts, "Gentlemen, we can no longer control the flow
of the world's currencies. We are now at the not so gentle mercies
of the markets." The implications were that countries would have to
actually subject their sovereignty to the opinions of the world
markets.
This was a blow to the ego of your average demi-god central banker,
but a big step in the cause of freedom. Next time you see a currency
trader, remember that he is just as much, and maybe more, a freedom
fighter as any armed partisan. Maybe he thinks he is fighting for a
few dollars at the end of the day, but the result is that
governments no longer can manipulate currency values beyond
reasonable levels.
So, back at the ranch, why is the dollar dropping earlier than I
thought it would?
First, my prediction was based upon gravity. The current account
deficit will pull the dollar down, and the Day of True Reckoning is
approaching later this year. I should point out that I am not the
only one who can see the obvious. You can bet every major currency
trading house can read the hand-writing on the wall as well.
So, if you can see it coming, why not get in front of the parade?
Because we have seen this parade coming for several years. Up until
this year, I ignored it, as foreign appetite for the dollar has been
more than enough to keep the dollar strong. Gravity was tilted in
the dollar's favor. But late last year, and early this year, you
could see those dollar flows slow down. That was when I wrote my
warning.
But I also assumed that the US would maintain a strong dollar
policy. By doing so, that would imply a slow and orderly retreat.
The euro goes to 95 by the end of the year, the yen to continue down
as the Japanese central bank seemed hades-bent upon destroying their
currency and nothing happens quickly.
Strike Up the Band
But now we have already seen the euro at 92 and the yen is rising,
not dropping. What gives?
The strong dollar policy is what gives. I believe the markets now
perceive the US will not intervene to protect the dollar. Here's
why.
"When asked a year ago about the end of the strong dollar policy,
U.S. Treasury Secretary Paul O'Neill was quoted as saying that he
would hire a band and march through Yankee Stadium if he was ever to
announce the end of the policy. Well, on May 1, Treasury Secretary
O'Neill paid a visit to Capitol Hill to speak on trade and
competitiveness.
"Everyone expected Secretary O'Neill to get up and say front and
center that he supported the strong dollar policy, and that it
remained in the best interests of the United States to maintain such
a policy. But then something amazing happened…he didn't mention the
strong dollar policy at all! He made two statements that led
currency traders to believe the strong dollar policy was being
phased out. First, he said that he didn't believe in intervention of
any kind….The one that really got the blood boiling was this little
ditty: "I am interested in doing whatever I can to help exports."
(Chuck Butler, Review and Focus)
When Treasury Secretary O'Neill talks about a strong dollar policy,
that is tantamount to intervention. The mere thought that the US
would enter the currency markets in a major way has to put the fear
of God into traders.
He may not rent a band and go to Yankee stadium, but currency
traders heard 76 trombones at that Senate hearing. When he says I
want to help exports and I am against intervention, it was like
turning on the blue light at K-Mart. Traders could see where gravity
would be taking the dollar, and if the US was not going to spoil the
parade, it was time to begin to move to the front. Shoppers began to
get in line, and the dollar has been dropping ever since.
How Far Down Is Down?
Let's put some perspective on this. I must have read 15 studies on
the dollar in the past few weeks. Many of them use words like
precipitous, dramatic, staggering, calamitous and explosive when
they talk about the drop of the dollar. But I can't find anyone who
uses an honest to Pete number with anything close to analysis I can
get my hands on. It mostly amounts to guesswork.
Are we talking 10%? 20%? 50%? And against what? And over what time
period?
When the euro was introduced two years ago, it came out at $1.13, if
memory serves correct. It dropped to $.81 and change, bounced,
dropped and is now back up to $.91. I think parity - that is one to
one - is in the cards.
If it does, that is almost a 25% increase in the euro from the
bottom, but it would still be 10% below its price of two years ago.
That is hardly staggering or even dramatic.
The yen is a few points off its low, but still much lower than a
year ago. The Japanese government is actually intervening to keep
the yen low. It will be interesting to see if this succeeds.
Remember, I said that a government cannot prop up a currency
indefinitely. Eventually they run out of reserves.
But the Bank of Japan can print as many yen as it wants. There is no
limit to the ability of a government to destroy its own currency.
They have clearly stated they want the yen to go lower so their
products will be cheaper in the US. If you can't trust a central
bank to keep its word when they say they want to destroy their
currency, then who can you trust?
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