Category: decoupling theory

More kind words for the U.S. dollar

We feel too many people are leaning the wrong way with the dollar. Mr. Market is set up to drive the most people crazy. If so, the scenario that drives the most people into a padded cell is inflation in the things they buy and deflation in the things they own on margin (although goods inflation and asset deflation could be relative). A credit crunch would bring this about and the knee-jerk reaction would be to get liquid, i.e. raise dollars.

Year-to-date, the vast majority of mutual fund flows are going into global funds, the Bullish Consensus on the dollar index is at 19%, Canadians are coming over the border to buy cheap American goods, and dollar bears like Peter Schiff are strutting around like peacocks. Though there is plenty of froth in the U.S. equity market, the real froth is in emerging markets (especially China). We think the idea that global markets escape the U.S. storm for the first time in modern history is pure fantasy, particularly with their best customer – the U.S. consumer – going into a coma. A good old fashioned contagion would squeeze out these excesses, returning the dollar to its original safe haven status, at least for awhile. Finally, the latest Grant’s shows Federal Reserve Bank credit growing at a 2.3% annual rate in the last 3 months and 3.6% in the past year. Meanwhile, European Central Bank assets grew at a 21.0% rate in the last 3 months and 12.3% in the past year. Why the ECB’s rapidly inflating fiat currency is head and shoulders above the American brand is beyond us, yet the vast majority of investors remain convinced.

The exception to being bearish on foreign currencies is clearly the Japanese yen (Bullish Consensus = 49%). 2-year government paper in Japan yields a miniscule 1.32%, not exactly a haven for investors. In fact, by some estimates, speculators have borrowed upwards of $1 trillion in the yield-challenged yen to lever up into higher yielding currencies like the Euro (93% BC), British pound (89%), Canadian dollar (93%), Aussie dollar, and New Zealand dollar. If, in fact, the great unwind is underway, this massive carry trade will largely liquidate itself to the yen’s advantage. Bank of Japan assets have actually contracted 4.5% over the past 12 months, although the BoJ has exanded its balance sheet at a 36.0% annual clip the last 3 months.

Over the weekend, the G-7 meeting failed to produce any political support for the dollar. Yet, after an initial drop, the dollar is rallying – perhaps a sign that the dollar pessimists have largely exhausted themselves.

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