Dollar Apocalypse / The Daily Reckoning

verfasst von - ELLI -, 12.02.2003, 14:45

-->Dollar Apocalypse

The Daily Reckoning

Rancho Santana, Nicaragua

Tuesday, 11 February 2003

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*** Saddam"bares all" - in an attempt to seduce Americans?

*** The gold-and-bond waltz may be in its finale...but gold
is warming up for a solo performance...

*** The dubious gifts of modern communication...U.S.
currency on a roll (downhill)...and more!

We don't have any idea what is going on in the outside
world. We drove down here from Managua yesterday and have
been trying to get an open phone line ever since.

Not having CNN in our house...nor a newspaper...nor even a
phone that works - we leave it to Eric to pass along the
day's news. Below, we turn to more important matters...

Eric?

-------------

Eric Fry, reporting from the Big Apple...

- Saddam Hussein raised the curtain once again on the Iraqi
"peep show," and investors took the gesture to mean that
the Iraqis might"bare all," rather than face the wrath of
American military might.

- Reversing weeks of opposition, Iraq said it would permit
U-2 surveillance planes to resume flying overhead, and also
promised to be more cooperative with U.N. weapons
inspectors. Apparently, Iraq doesn't mind if Uncle Sam
becomes a peeping Tom, as long as the peeping takes place
from 60,000 feet in the air.

- Given Iraq's latest concession, the prospect of an
imminent American assault has faded somewhat, and with it
the allure of safe-haven investments. Gold tumbled $6.30 to
$364.20 an ounce. Crude oil also retreated from its recent
highs, falling 64 cents to close at $34.48 a barrel.

- Meanwhile, a few intrepid investors ventured back into
the stock market. The Dow gained 56 points to 7,920 and the
Nasdaq added 1% to 1,296. The bond market barely budged, as
the 10-year Treasury note finished the day right about
where it began, yielding 3.97%. But the bond market might
merely be enjoying the calm before the storm.

-"Just because the bond 'bubble' hasn't burst yet, doesn't
mean it isn't a bubble," the team at Resource Trader Alert
(RTA) observes."War anxiety and subsequent flight-to-
safety buying may have postponed the day of reckoning, but
hasn't necessarily eliminated it. Inflation in both the US
and the euro zone is headed higher, if for no other reason
than higher energy prices. Oil is up 65% from a year ago
measured in dollars and up 35% when measured in euros.

-"But it's not just oil," the RTA team continues."The
broad-based CRB Index of commodity prices is up a whopping
32.2% from its 2002 lows...Massive increases in money
supply, a return of deficit spending and the inflationary
effects of war make it hard to justify the low yields and
correspondingly high prices of Treasury bonds and
notes...Big borrowing needs in both the U.S. and Europe
have the potential to flood the market with paper over the
next few years...The Bush administration projects U.S
government deficits to top $1.8 billion over the next five
years..."

- All in all, there are lots of reasons why NOT to love
bonds at their current low yields. Still, certain option
traders may be set to profit nicely from an imminent sell-
off in the Treasury market... [Editor's note: for more
information, see: Resource Trader Alert
http://www.agora-inc.com/reports/RTA/ClickHereNow/]

- What may be bad news for bonds is, as every Econ. 101
student knows, good news for gold...at least most of the
time. Curiously, bond prices and gold prices have been
rallying arm-in-arm for months. But that dance is likely to
end very soon. The nascent inflationary trends developing
in the U.S. are likely to be VERY bad for bonds and VERY
good for gold. That's why most of us at the Daily Reckoning
are fans of the yellow metal. Even so, we can't help but
wonder when gold's awesome, months-long rally might take a
breather. Was yesterday's sell-off the beginning of gold's
pause that refreshes?

- Given gold's dramatic run-up, an equally dramatic sell-
off wouldn't be too surprising. But longer term, we
wouldn't want to bet against this precious metal. Gold is
in a long-term bull market, until further notice.

- Long-term investors who'd rather not bother trading every
"jiggle" (Jimmy Roger's term) in the gold market, will be
heartened by the observation of Frank Holmes, CEO of the
mutual fund company U.S. Global (Nasdaq: GROW). Holmes
calculates that, over the last 30 years, an investment
portfolio containing a 20% allocation to gold stocks has
produced a higher return with less risk than a portfolio
dedicated entirely to the S&P 500 Index.

- An 80% mix of S&P 500 Index shares, says Holmes, together
with a 20% mix of Toronto Gold and Precious Mineral Index
shares, achieved an average annual return of 12% from 1971
through 2002. That return was higher, and less volatile,
than a pure S&P 500 holding.

- History is nice, but most of us would prefer to know what
the optimal portfolio allocation might be for the NEXT 30
years, rather than the last 30 years.

- Faithful Daily Reckoning readers, we suspect, would
prefer kissing their sister (or brother) to allocating 80%
of their portfolios to S&P 500 shares. And we'd hate to
have those sorts of choices made on our account. So let's
skip over the S&P 500 part of this discussion and focus
only on the gold part.

- For the next 30 years, some meaningful allocation to the
yellow metal seems like a good idea. Whether the optimal
weighting might be 20% or 2% is anyone's guess. But if the
dollar is past its prime - which is a possibility - even a
hefty 20% allocation to gold stocks would seem inadequate.

-------------

Back in Nicaragua...

*** Being cut off from the news is a terrible thing. With
no CNN to watch, a man is forced to look around him...with
no presenter to listen to, he must listen to his
wife...with no talking heads to do his thinking, he is
forced to think for himself.

This comes as such a burden to your editor that he can
hardly bear it. He would much rather read about the world
environmental crisis...than take out the trash. He would
much rather discuss Japan's economy than balance his own
checkbook. He finds it easier to write a letter to the
editor than one to his sister.

"Love afar is spite at home," wrote Emerson. But the modern
press makes it so easy. No cause...no problem...is too
remote or obscure to tempt away the imagination of the
public-spirited Democrat. He may not be able to fix the
bathtub drain - for he is too busy worrying about the
sewage in New Delhi. His own children may spend the day
watching television and eat moon pies for breakfast, lunch
and dinner...but it is a small sacrifice to pay for a his
keen interest in health care policy. 'Regime change' speaks
to him like an advertisement for a potency pill...he cannot
resist it, whether he needs it or not.

Here, in the wilds of Nicaragua with the waves crashing
against the rocks outside his house...a huge SUV land barge
parked in his driveway...and no newspaper delivered to his
door, your editor wonders what the world would be like
without modern communications...

[Editor's note: If you've sent an e-mail to us in the past
few weeks and we haven't responded...don't despair! We
always like to here from you; in fact, it's one of the more
pleasing aspects of our work. But as many of you know, we're
working on a book to be published by Wiley & Sons, and the
deadline draws near. We simply haven't had time to respond.
Thanks for your understanding. Back on the job soon!

À bientôt,

Addison Wiggin,
The Daily Reckoning]


The Daily Reckoning PRESENTS: Compared to its trading peak of
less than $0.86, the U.S. dollar has lost altogether 22% against
the euro. What does this imply...and where will it end? Kurt
Richebächer gives us his take on the U.S. currency below.


DOLLAR APOCALYPSE
by Kurt Richebächer

Entering the New Year, the dollar's fate is definitely the
single most important question for the world economy and world
investors. It is really the greatest wild card in the world
economic outlook. After a very slow start, the dollar's
decline has been gaining momentum. But where will it end?
Could last year's dollar retreat turn into a dollar crash,
possibly with disastrous implications for the U.S. financial
markets if not for the whole financial system?

On Dec. 31, 2002, the euro traded against the dollar at $1.05, up
from $.8915 at year-end 2001, reflecting a gain of 17.8%.
Compared to its earlier peak of less than $86, the U.S. currency
has lost altogether 22%. For European investors, these currency
losses are adding hugely to their heavy losses on U.S. stocks.

The dollar index topped out a year ago. Starting very
hesitantly and gradually, its fall has distinctly gathered
momentum in recent months. Considering the resistance of the
trade deficit and the worsening economic situation in the
United States, it is plainly time to ponder a protracted
decline of the dollar and its broader implications. What could
stop the dollar's slide? And what could happen in financial
markets if the dollar's slide proves unstoppable?

As for the first question, it is established experience that
trade balances respond to changes in the exchange rate with
enormous sluggishness, if at all. During 1985-87, the deficit
continued to soar, even though the dollar virtually collapsed.
In essence, such a deficit reflects an equal excess of
domestic spending over domestic output. But currency
depreciation, by itself, affects neither of the two. To reduce
its trade deficit, the United States would need to lower
consumer spending. But that is precisely what the government
and Federal Reserve are desperately trying to prevent, as it
implies recession and rising unemployment.

While sharply slower U.S. economic growth in 2003 may
moderately improve the trade deficit, the worsening economic
news would frighten foreign investors even more. It is, in
actual fact, one of our key assumptions concerning the dollar
that an unexpectedly poor performance of the U.S. economy and
its stock market in the current year will act as the catalyst
that will finally break the illusions about the U.S. economy
and the dollar.

While the indulgence of foreigners to invest in the United
States is incredible, sharply lower capital inflows are
effectively depressing the dollar. With this in mind, the
second question becomes paramount. What will happen if the
dollar continues its irresistible decline?

Up till now, the dollar's decline has been orderly, for an
obvious reason. Inertia rules - there remains a fixed, very
negative image of the European economy and its currency versus
a fixed, very positive image of a dynamic American economy
trumping the trade deficit with a superior growth performance.
The result is a still-predominating view in the markets that
the euro's rally is narrowly limited, while the dollar's next
recovery is only a question of time.

Yet this faith in the dollar's impending rebound must be
fading. Its decline is ominously gaining speed. The usual
explanation is the war in Iraq. In the past, though, the
dollar used to enjoy safe-haven status. In actual fact, there
are plenty of other reasonable explanations for a weak dollar.
Most of them are not new. But what is new is the proliferating
bad news about the U.S. economy, putting its expected recovery
into question. In short, confidence in the U.S. economy's
growth prospects is cracking.

Could the dollar's orderly decline turn into a chaotic
decline, capsizing the financial markets? Look back to 1987, a
year in which American and foreign investors did lose their
nerve about the falling dollar. For several months, this loss
of confidence spelled disaster for U.S. stocks and bonds. Yet
it proved a brief crash, which ended in a soft landing for the
dollar and the markets. As such, it seems a comforting
experience.

On closer look, it is not. Today's economic and financial
conditions in the United States are incomparably worse than
they were in 1987-89. Economic growth is much slower today,
the trade deficit is much higher and interest rates are much
lower.

But there is yet another factor that makes a great difference:
unprecedented exposure to the risk of a falling dollar. Both
foreign holders of dollar assets and American holders of euro-
denominated assets have much at stake. The important point is
that both groups have principally abstained from covering
their exchange risk. Strong expectations to gain from a strong
dollar or from a weak euro prohibited any hedging. When will
foreign investors and American borrowers finally give up on
the strong dollar?

There is a widespread assumption that there exists a"normal"
level of the dollar against other currencies, from which it
will not diverge too far or for too long.

But no such level exists. The dollar is effectively out of
control. There is no way to predict where it may bottom. This
is a measure of the macroeconomic costs of allowing an
external disequilibrium to become so large and to accumulate
for years. The dollar's fate no longer lies in the hands of
central banks or private banks, but in the hands of many
millions of fickle private investors.


Regards,

Kurt Richebächer,
for the Daily Reckoning

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• Dollar Apocalypse / The Daily Reckoning - - ELLI -, 12.02.2003, 14:45