No love for the dollar

A lot can happen in two weeks. Normally the foreign exchange market for developed nations move like glaciers. But in these days of global warming even glaciers are breaking speed limits.
Less than two weeks ago the World Bank President had some interesting things to say regarding the dollar.

"The United States would be mistaken to take for granted the dollar's place as the world's predominant reserve currency," Mr. Zoellick told the School of Advanced International Studies of Johns Hopkins University.
In his strongest comments yet in the debate over the dollar's reserve-currency status, Mr. Zoellick said that, "looking forward, there will increasingly be other options to the dollar."

For 65 years the American dollar has been the world's reserve currency. Practically as good as gold. So Mr. Zoellick's words might be considered controversial.
However, this was merely the start of several startling revelations.

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Just a week later the U.N. joined the dollar bashing theme.

In a radical report, the UN Conference on Trade and Development (UNCTAD) has said the system of currencies and capital rules which binds the world economy is not working properly, and was largely responsible for the financial and economic crises.
It added that the present system, under which the dollar acts as the world's reserve currency , should be subject to a wholesale reconsideration.
Although a number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency, the UNCTAD report is the first time a major multinational institution has posited such a suggestion.

China and Russia have been calling for a new world currency regime since March. While their opinions matter, they couldn't knock the dollar off its pedestal alone. They needed cooperation for other nations and international groups.

The U.N. calls for a new world currency system comes just three months after the IMF proposed its own solution - Special Drawing Rights.
SDR's aren't an actual currency. They are more like a basket of currencies that act as a claim on real currencies. SDR's were originally created in 1969 when the Bretton-Woods system was breaking down, to replace gold and silver on international transactions. SDR's were called "paper gold" at the time.

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The advantage of using SDR's for creditor nations like China is that it diversifies their currency reserves and functions as a "transitional reserve currency" until a new currency can take the dollar's place. Disadvantages are that only a few currencies make up an SDR and the total amount of SDR's is limited.
So the danger that SDR's pose to the dollar are limited without further efforts by the world's creditor nations. Which makes this news report disturbing.

In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

It was no secret that China and Russia are unhappy with the dollar hegemony. Same goes for OPEC nations such as Iran (which no longer sells oil for dollars) and Venezuela. But when Japan and Dubai jump on board this becomes very serious.
Fisk's article was met with thunderous official denials from all over the world. However, there was a certain lack of credibility in those denials if only because a meeting like this is the next logical step in doing what these countries have been talking about for months.

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A skeptic might point out that all this talk about countries moving away from the dollar is just talk without any concrete action. That brings us to today's revelation.

(Bloomberg) -- Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two- quarter rout in almost two decades.
World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors. The diversification signals that the currency won’t rebound anytime soon after losing 10.3 percent on a trade-weighted basis the past six months, the biggest drop since 1991.
“Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it,” said Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays in New York. “It looks like they are really backing away from the dollar.”
The dollar’s 37 percent share of new reserves fell from about a 63 percent average since 1999. Englander concluded in a report that the trend “accelerated” in the third quarter. He said in an interview that “for the next couple of months, the forces are still in place” for continued diversification.

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That counts as "concrete steps".
The dollar bulls have several responses to these bearish forecasts.
The first, and most obvious one would be that this only involves official movements. It doesn't include private foreign investors. However, a deeper reading of Barclay's article effectively ends that discussion.

Since the global recovery got underway at the beginning of Q2, the USD has been among the weakest of the major currencies. By definition this means that the US current account funding needs, while lower, were not reduced enough to stabilize the dollar. Other data, in particular the US Treasury TIC data, show unambiguously that there has been an outflow of capital from the US. The US private sector has been buying USD30-40bn of foreign portfolio assets, effectively doubling the financing need implied by the US trade deficit. The foreign private sector has been selling US Treasury obligations.

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The second point the dollar bulls will point out, and it is a good point, is that if foreign selling of dollar assets are so significant, then why are stocks and bonds doing so well? Shouldn't the selling show up there first? After all, if stocks and bonds don't care then how much effect does it really have?
It's a good point, but there is a huge caveat - no one is buying Agency debt except for the Federal Reserve. Not even private domestic investors want anything to do with Fannie Mae and Freddie Mac debt. Mortgage rates are so low right now because the Federal Reserve is printing money out of thin air and buying mortgages on the secondary market, sometimes in as short as just 90 minutes.
It isn't just Agency debt. The Fed has been active buyers of Treasury debt as well.

While this pushes down interest rates, it also acts to push down the dollar. The Federal Reserve is not only dramatically expanding its debt obligations, but its balance sheet is getting filled up with mortgage-backed securities of questionable quality.

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Of course massive federal deficits for years to come also directly contribute to the decline in the dollar.

So what does this all mean? Is the dollar doomed? Should we all rush out and exchange our dollars for euros and yen?
No. The trade sentiment against the dollar is getting very crowded, and anti-dollar articles are easy to find these days. This is usually a sign of a coming dollar rally.

The dollar will not be allowed to collapse. Instead its decline will be managed. This will include violent corrections that will savage any dollar bear who is trying to make a quick buck.
However, if your investment timeline is measured in years rather than months, then betting against the dollar is a good trade. The dollar's fundamentals are terrible and it is only being supported because of the lack of a clear alternative. That won't last forever.

The Golden Rule

Imagine for a moment that there is an asset that has gone up in dollar value every single year for eight straight years, is about to have one of its best years in 2009, and is the best performing asset class of the decade.
Imagine that this asset has been going up in value in every currency in the world over the last five years.
Imagine that worldwide demand for it is hitting all-time records while outstripping supply. At the same time worldwide production of it has fallen 10% over the same period.
Imagine that as recently as 2002 private ownership of this asset was outlawed in China, and now China is about to become the largest consumer of this asset in the world. In just the last month China's government started encouraging private consumption of this asset.
Imagine that worldwide government selling of this asset has turned into worldwide government buying of this asset for the first time in over 40 years.
Imagine that all the major commercial producers of this asset are positioning themselves for years of rising prices.
Imagine that this asset has absolutely no danger of becoming worthless, and that its value only increases when the dollar declines.

Now imagine that professional investment advisers on Wall Street, who wouldn't hesitate to sell you black-market kidneys and weapons of mass destruction, if it were legal and they could make a profit on it, have universal disdain for this asset.
Imagine that if you mentioned buying this asset at a neighborhood party someone would be sure to think you are a kook.

Wouldn't it make you wonder what is wrong with this picture? Why is nearly everyone so dead-set against buying an asset that goes up in value every year, and who's fundamentals keep improving?

Yet that is the world that gold exists in today. The price of gold is hitting all-time highs, but unlike dot-com stocks in 1999, or house flipping in 2005, few people care.

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The central banks of the world increasingly view the future with gold as a currency. On the other side, you can always tell gold's detractors because they still think we are in the 1980's.

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Comments

This is a great post

gives a lot of clarity on the state of the dollar and frankly, makes me think I've been wrong. I have been thinking this is a bunch of "brew ha ha" due to foreign debt holdings.

Seeing all of the recent events together in one piece, well, this is looking bad for dollar hegemony.

On gold, I'm not so convinced, unless I'm wrong and somehow gold is still linked to some currencies in the world.

(although I am in the "it's going to $2k an ounce camp regardless")

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Gold and the Volcano God

On gold, I'm not so convinced

Of course not. If you were then you wouldn't be allowed into the Church of the Volcano God and never be taken seriously in the investment community.

Let's put this another way:
Let's say instead of finding this asset on the periodic table, it was a creation of alchemists on Wall Street.
Somehow they had found a way to make a product that had zero chance of default and had zero risk from currency fluctuations.
This Wall Street product went up every single year and was the top performing investment of the decade.
Even more importantly, it's demand kept increasing as its customer base expanded, while at the same time its supply kept decreasing.

Given all that, do you think for a second that this wouldn't be the hottest product on the market? There would be ad men pitching this product on CNBC around the clock. It would be the main topic of conversation at cocktail parties. Your broker would tell you that you HAD to have some of this in your portfolio.

The problem is that this ISN'T a product of Wall Street. It's a product of nature. And for that reason, and that reason alone, you can't believe in it and still be allowed into the investment club. It would anger the Volcano God.

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double down

Last night I put in some call options on GLD. So, it's not like I'm not that convinced, although the speculation bets on all things related to physical gold are at an all time high.

;)

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Short-term technicals

Right now the short-term technicals for gold and the dollar are at extremes. They point towards an imminent rally in the dollar and drop in gold.
However, the fundamentals, including seasonal factors, are very strong for gold.

If I was to make a guess I would say the coming correction in gold will be mild.

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for the gold bugs

I see in the statistics they scour the Internets looking for any info at all..

so putting up some technical charts for them, they would love it.

Myself, what you're saying is pretty much what I did. I went for March 2010 options and I have a limit order for when they correct, so I didn't just buy them, I'm looking for that correction dip, assuming it will happen in the next couple of months. But I didn't do a technical chart to figure out the exact price. I guess I should do that instead of sticking my thumb in the air and guessing on the price bottom!

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Sumitomo: Dollar to hit 50, cease to be reserve

I'm not sure I can believe any bank about anything, but this is still worth noting.

(Bloomberg) -- The dollar may drop to 50 yen next year and eventually lose its role as the global reserve currency, Sumitomo Mitsui Banking Corp.’s chief strategist said, citing trading patterns and a likely double dip in the U.S. economy.
“The U.S. economy will deteriorate into 2011 as the effects of excess consumption and the financial bubble linger,” said Daisuke Uno at Sumitomo Mitsui, a unit of Japan’s third- biggest bank. “The dollar’s fall won’t stop until there’s a change to the global currency system.”
...
“We can no longer stop the big wave of dollar weakness,” said Uno, who correctly predicted the dollar would fall under 100 yen and the Dow Jones Industrial Average would sink below 7,000 after the bankruptcy of Lehman Brothers Holdings Inc. last year. If the U.S. currency breaks through record levels, “there will be no downside limit, and even coordinated intervention won’t work,” he said.

And on a related note, there is no shortage of dollar bears out there.

A former US deputy assistant treasury secretary and now head of Encima Global, David Malpass is quoted saying, "Money wants to go to where it can get a steady return in real money, not in funny money. And in many ways the dollar is becoming the funny money currency for the world."

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I don't know what to make of this either

Is it huff and puff or is it all a dire warning that the U.S. dollar is imminent to be removed as a reserve currency?

I have a hard time believing the globe would let that happen in a sudden move, unless they wanted to bring down the U.S. in some sort of financial terrorism. It would cause the entire financial globe to collapse I think.

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Eventually

Things change. Armand Hammer predicted $100 a barrel oil back in the 1980s -- he didn't live to see it happen. And China will eventually be a developed nation. In the shorter term, I believe dollar weakness is convenient policy. I have been scaling in to Aussie dollar and Brazilian utilities (not a recommendation -- just my take on self-preservation in the current craziness). I see the "50 yen" target as much less important than shorter term market forces. Yes, I'd rather be paid in yen and euros, but my clients pay in dollars and my monthly bills are denominated the same way. As a matter of policy, I'd like to see all Fed governors and Treasury officials required to have all their personal holdings in dollar assets. Align their interests with ours.
Frank T.

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Frank T.

Wow that's amazing

and devastating for the Japanese transplants in North America.

As recently as 2007, the rate was 124 yen to a US dollar.

To put that into context.

That means that an engine costing $2500 to import from Japan in 2007 at 124 yen to the USD would now cost $6200 at 50 yen to the USD. At that exchange rate, it would be almost impossible for the transplants to get away with importing much at all from Japan. At the same time, Toyota has purposely cut their production in the United States, to centralize production in Toyota City.

This is a train wreck waiting to happen. And when it does, the Japanese economy is going to get pulled back under from the modest growth it's shown recently.

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Russia and Iran moving further away from the dollar

Iran is getting totally out of dollars.

TEHRAN (FNA)- The Trade Promotion Organization of Iran (TPOI) announced that it plans to exclude the US dollar from the country's foreign exchange reserves.
Since October 2007, Iran has received 85 percent of its oil revenues in currencies other than the US dollar and Tehran is determined to find a substitute for the US dollar for the rest of its 15 percent of oil revenues, the report added.
Iran suggests other currencies such as the euro and the United Arab Emirates' dirham to replace the US dollar for oil revenues.

It looks like Iran will be the first nation to totally reject the dollar. No wonder we are rattling sabers at them.
More important is the developments in Russia.

(RIA Novosti) - Russia is ready to consider using the Russian and Chinese national currencies instead of the dollar in bilateral oil and gas dealings, Prime Minister Vladimir Putin said on Wednesday.
The premier, currently on a visit to Beijing, said a final decision on the issue can only be made after a thorough expert analysis.
"Yesterday, energy companies, in particular Gazprom, raised the question of using the national currency. We are ready to examine the possibility of selling energy resources for rubles, but our Chinese partners need rubles for that. We are also ready to sell for yuans," Putin said.
He stressed that "there should be a balance here."
On Tuesday, Russia and China agreed terms for Russian gas deliveries at a level of up to 70 billion cubic meters a year. China also imports oil from Russia.

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