By: Dr_Jeff_Lewis
Even silver and gold bears realize that the dollar is in decline, but few realize the extent of such a decline and how massive shifts in capital flows in 2008 will affect the dollar in 2011.
The Flood into the US Dollar
If you remember back to the days surrounding the credit crisis, you will probably first think of the massive opportunity to buy silver at $9 per ounce. However, now think more retail. Think of what happened when the world was struck by fear: they bought dollars.
Despite its shortcomings, the dollar is still one of the best currencies in the world, which says a lot about the other currencies around the world. When the worst financial crisis in decades hit the markets, investors fled to safety, and so they fled into the US dollar. However, when you invest in dollars on a massive scale, it does not make much sense to just horde a bunch of paper, nor is it practical to store cash in a bank account of a possibly failing bank.
Besides, at the time, accounts were only insured to $250,000, which may be sufficient for the middle class, but to the institutional investor, it’s only a rounding error. So where do you put tens of billions of dollars for safekeeping? You put it in Treasuries, where hopefully you will earn a positive yield on your money while you wait in safety for the storm to pass.
Bogged Down by Treasuries
Fast-forward to 2011, and the markets are beginning to relax. The emerging markets are finding stability, and the Europeans have bailed out their neighbors to such an extent that the Euro isn’t as treacherous as it once was. With stability comes predictability, and with predictability comes an appetite for risk.
While many see the dollar to be a declining currency due only to the bank behind its monetary policy, it also has a great deal of short-run influences that will greatly affect its value once calmer markets earn investors’ trust. Because so many institutions, governments, and bankers bought into Treasuries at the height of the crisis, they now hold dollars in amounts that greatly affect their portfolio weighting. And while the dollar may be one of the best of the worst, rarely does it make sense to be weighted strongly in one investment for safety. Instead, diversification proves better than buying one single safety asset class.
When the world begins to diversify out of the dollar, they won’t just be selling their dollars, but they’ll be selling government debt. What does that mean for the US? It means double pressure against the valuation of the dollar (more supply, still insignificant demand) and against the value of US debt (more supply, and still no real demand).
A Vicious Cycle
This scenario is what practically necessitates a new round of quantitative easing. In order to continue deficit spending, the Fed will buy another round of Treasuries, and in order to defend the dollar, the Fed will have to devalue the dollar to buy the dollars circulating in the form of debt. And you thought quantitative easing round two was the end of monetary stimulus? Not a chance.
No comments:
Post a Comment