The U.S. dollar is weak, and the U.S. administration has no choice but to continue to allow the currency to weaken.

As we have pointed out in these pages many times, the U.S. has to finance huge budget deficits for this year and for the foreseeable future.  This must be done by selling bonds.  Primarily, the sales will be made to non-U.S. buyers.  The U.S. has two options if it wants to sell trillions of dollars in bonds to foreigners:

1.  Raise interest rates substantially.
2.  Let the dollar decline and make U.S. bonds cheaper to foreigners who hold foreign currencies.  When the dollar is cheaper, the bonds become more attractive as they have fallen in price in Euro, Yen or other foreign currency terms.

We have previously gone through the details of why raising interest rates is not viable.  In short, it is too expensive, it damages current and future business conditions, it hurts exports, etc.  (You may look our discussions of this up in the Guild Investment Management archives)



In our opinion, the way to hedge the weak dollar is to invest in oil, precious metals, foreign currencies, foreign stocks, and markets [if the country and the company in which you invest can grow through the current period of depressed global economic activity].

It is a simple formula: just avoid the U.S. dollar.  Invest in assets that go up as the dollar falls.  Oil is denominated in dollars, and it gets cheaper for foreigners as the dollar declines.  Gold and other currencies [gold acts as a currency-and a very strong one at that] rise in value versus the dollar.  We prefer to stick with the oil producing countries’ currencies, strong commodity currencies, and the better emerging market currencies.

We own gold shares, oil shares, Chinese stocks, Brazilian stocks, Indian stocks, Canadian dollars, Australian dollars, Norwegian Krona, and Euros.  We consider Norway, China and Brazil to be well managed economies.  We believe that India’s economic management is improving.  The Euro represents a big and liquid alternative to the U.S. dollar, even though some of the countries in the Euro zone are not well managed.

We may change our positions at some future time, but currently this is our approach and we expect it to work very well in coming months.

AUD vs. USD – One Year

Euro vs. USD – One Year


Some anecdotal evidence of the previous statements is that historically gold and oil demand falls in the summer period, and the prices of gold and oil usually follow.  This is due to decreased heating demand for oil, decreased jewelry demand for gold, and slowing business activity as a result of summer holidays.

This year, oil and gold prices have been rising in May instead of falling.  We believe that this is due to the fact that oil and gold have not risen as much in price for holders of non U.S. currencies. Gold has risen from $867 on April 17, 2009 to $956 today (about 10% in U.S. dollar terms).  In Euros, gold has risen only about 5% over the same time period.  In other words, gold remains relatively cheap.  It also is growing in attraction due to the fact that many foreign owners of U.S. dollars do not want to be stuck with a currency that is declining in value.  To say it another way, the dollar is losing purchasing power.  To maintain purchasing power, investors will switch out of U.S. dollars into currencies which are maintaining purchasing power.


In addition to the well-publicized issues about having the freedom to pay more to executives and  top employees, and the freedom to continue to manipulate derivatives, BANKS ARE AFRAID that they will be forced to buy a large amount of U.S. government bonds in order to help finance the budget deficit.

This is especially true for the banks which are fully or partially controlled by the government.  Therefore, it is no surprise to us that they all want to pay back TARP funds as soon as possible. The government may have to require such banks to begin buying government debt.


In the U.S., some stocks will do well because they are able to enjoy benefits from a declining U.S. dollar.  A falling dollar may provide business conditions in their industry or sector.  Others will have problems as the U.S. administration is unfavorable toward them.

Among U.S. industries that the current administration has targeted are: credit card companies, steel producers, coal companies, drug companies, and utilities.  [Coal, steel, and utilities because of the carbon tax, and drug and credit card companies because the populist pressure to lower costs to voters.]  Investors should avoid these industries in the U.S. and focus on them abroad where they are more likely to prosper, especially steel and coal. It also means credit will become less available and consumption will suffer.  Utility prices will rise, and this will cause inflation.  Drug prices will fall, but new drug development will slow.


Interest rates have been rising in the U.S.  People must have come to the realization that there is going to be a big auction of U.S. Treasury bonds this week, and the U.S. government had been doing less quantitative easing than had been hoped for.  This has caused U.S. interest rates to rise and will undoubtedly cause the U.S. dollar to continue to fall over the longer term as the U.S. tries to sell trillions of dollars of bonds to an unwilling buying public.  As we mentioned earlier, there are two ways to entice buyers fro these bonds.

Raise interest rates substantially. Interest rates are rising somewhat, but raising them substantially is not an option because it would stifle U.S. economic growth and cause an even longer and more difficult depression than the one we are currently enduring.
Lower the value of the dollar makes it less expensive for those who have foreign currencies to buy our bonds.

Both #1 and #2 are happening, but #2 is happening more rapidly.

We always like to follow the money. U.S. money and U.S. power have been leaving for some years, much of it headed to China.  The current decline in the U.S. dollar is part of a long term process…a process that includes rising oil, gold and other currencies, as well as other commodity prices. Gold is being acquired by China and other surplus countries. Deficit countries like the US and Europe will be tempted by ignorant political advisors to sell gold. If they choose to do so, their currencies will fall more rapidly and gold will rise faster. We can rest assured the China and other surplus countries will buy all of the gold before it hits the public market.  The following article from last Friday’s Financial Times discusses the dollar’s predicament.

Dollar’s fall reflects loss of haven appeal
May 22, 2008-By Peter Garnham

Increasing confidence that the world might be past the worst of its economic and financial woes has been good for many assets in recent weeks – equities, corporate bonds, and commodities – but it has certainly not favoured one asset, namely, the dollar.

The US currency has fallen 10 per cent since it hit a three-year high on a trade-weighted basis in March. This week it reached its lowest point against a basket of currencies since December.

Some pundits expect the dollar’s woes to continue.

"We long warned about the day of reckoning for the dollar emerging at the next economic recovery," says Ashraf Laidi at CMC Markets. He says real demand for commodities combined with improved risk appetite will push investors to seek yield in emerging markets and commodity currencies, away from the fiscal deficiencies of the US economy.

The dollar rallied strongly after the collapse of Lehman Brothers last September as massive deleveraging sent investors scrambling for the safety of the currency and US assets.

The main casualties were emerging market and commodity linked currencies as investors braced themselves for a collapse in the global economy.

But signs of stabilisation, combined with rallying equities and reduced volatility, have soothed investors’ nerves.

That has removed some of the dollar’s haven support, prompting fears that just as the dollar benefited when investors scrambled out of risky positions, so it will suffer as they seek out yield. The dollar has fallen nearly 10 per cent against the euro, dropped 8.8 per cent against the pound and lost 3 per cent against the yen since March.

Emerging market and commodity-linked currencies have rallied even more against the dollar over that period, with the Australian dollar up 20 per cent, the Brazilian real 15 per cent stronger and the South African rand up 16 per cent.

John Normand, at JPMorgan, believes that the global economy has turned the corner. "The dollar will be the main casualty, since US growth will come with lower interest rates, higher inflation expectations and greater financing risk than most other economies," he says.

He adds that investors risk repeating a frequent mistake: underestimating growth at turning points.

"Given the amount of money stockpiled in cash after the Lehman bankruptcy and still undeployed after this spring’s equity market rally, any upside surprise would renew the dollar’s downtrend," says Mr Normand. JPMorgan puts this stockpile at about $700bn.

"Even if the recovery proves mediocre, these cash levels look inordinate," says Mr Normand. "The upside on risky markets and the downside on the dollar from reallocation still look decent, even after the moves of the past two months."

There are increasing signs that the tight correlation between equities and the dollar is breaking down.

In recent months, the dollar has benefited when risk averse investors fled falling stock markets, but it has fallen at times of higher risk appetite and rallying stocks.

This week the dollar and equities have fallen after the Federal Reserve revised down its growth outlook and increased its unemployment projections.

"The fact that weakness in US stocks failed to help the dollar in terms of a risk aversion bid reveals that dollar bearishness is becoming more entrenched," says Mitul Kotecha at Calyon.

He expects investors to focus on other negatives for the dollar, including worries over the US fiscal position and the effects of the Federal Reserve’s quantitative easing programme.

Analysts say worries over the US fiscal position are only likely to be heightened by the downgrade yesterday from S&P, the rating agency, to its outlook on UK sovereign debt.

Chris Turner, at ING Capital, says the US went into the financial crisis with a worse debt to gross domestic product ratio than the UK – 63 per cent against 44 per cent – and most organisations, including the International Monetary Fund and the Organisation for Economic Co-operation and Development, expect the US ratio to hit 100 per cent before the UK.

"The market is right to ask whether a US ratings outlook change could occur shortly – which would be very bad news for the dollar," says Mr Turner.

Derek Halpenny, at Bank of Tokyo-Mitsubshi UFJ, says the impact of US monetary policy on inflation expectations will dictate the performance of the dollar.

He says longer-term inflation expectations may creep higher over the coming months if the Fed increases the scale of asset purchases in its QE programme in an attempt to boost the domestic economy.

"The danger may well be that financial market participants speculate that US policymakers are engineering a weaker dollar as part of the overall plan to fight deflation," he says.

That would ring alarm bells among the holders of the world’s main foreign exchanges reserves, the vast majority of which are held in dollars.

China, the world’s largest reserve holder, has repeatedly voiced its concerns over the value of the dollar and, along with Russia, the world’s third largest reserve holder, has urged a move away from the dollar as the world’s reserve currency.

Such a move is unthinkable in all but the very long term. But this highly-sensitive issue might chip away at the dollar, as witnessed by the attention given to reports this week that trade between Brazil and China might soon be transacted in real and renminbi.

An official from the China banking regulatory commission suggested this week that the renminbi could become a bigger reserve currency, accounting for 3 per cent of global reserves by 2020.

"This process will be very slow, especially as the renminbi is not fully convertible," says Steve Barrow at Standard Bank.

"But it is clearly an issue that could slowly eat away at the dollar, given that the US currency would seem to have most to lose as the renminbi’s global role increases."

Thanks for listening.

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