Losing Confidence in the US dollar

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With the World War D investing conference done and dusted, we pause to reflect on it all. What was our key takeaway from the two-day event?

In short, ‘bear fatigue’. That is, the keynote speakers (Marc Faber, Jim Rickards and Richard Duncan) all made the case that we are heading towards a financial collapse…we just don’t know when. More to the point, multiple forms of can-kicking can potentially delay the inevitable day of reckoning for years to come. Therefore, to use the words of Citigroup boss Chuck Prince in 2007, while the music is playing, you gotta keep dancing.

Having suffered a bit of bear fatigue our self, we sympathise with this viewpoint. And sure, there’s room for a small amount of speculation in any portfolio. But succumbing to this fatigue is akin to throwing discipline out the window and investing just because…well, everyone else seems to be doing it.

While no one knows how long the financial system can continue its debt based expansion, Marc Faber suggested that with the bull market now entering its sixth year, it’s getting old and due for a correction. Jim Rickards thinks we’re in a bubble, while Richard Duncan reckons the US government could in theory keep the music playing by running up debt levels from the current 100% of GDP to a Japanese-like 250% of GDP.

In practice he doesn’t think this will happen and he nominates collapse as the likely outcome. Nevertheless we subsequently asked him how this was possible given that Japan is a net creditor nation (and therefore has accumulated savings to fund its deficits) while the US is a net debtor nation and relies on the savings of foreigners to finance its debts.

In other words we wondered whether the rest of the world would finance a more than doubling in the US’ already gargantuan total debt levels.

He said that because the US dollar is the world’s reserve currency, and the US issues its debts denominated in the reserve currency; as long as people go on accepting the dollar’s reserve role they will keep buying dollar based debt.

That’s true in theory, but somewhere between the current 100% debt to GDP ratio and 250%, we’re tipping that you’ll see a change of attitude about the US dollar as the world’s reserve currency.

In fact, you’re already seeing it. According to Treasury data, in the year to January 2014, official holdings (i.e. foreign central banks) of Treasury bonds and notes actually fell by US$78.3 billion. On a net basis, foreigners dumped US$336 billion in long term US securities in the 12 months to January 2014.

The only thing holding up the dollar is the fact that they didn’t repatriate the proceeds. According to the Treasury’s data, a US$540.7 billion increase in ‘dollar-denominated liabilities’ (US dollar cash holdings) more than offset the selling in other assets.

As far as we can tell, foreigners are already losing their appetite for US assets, but instead of fleeing completely they are parking the money in cash…an area they can exit at the shortest notice. When they do, the US dollar will fall heavily.

This steep reduction in foreign appetite for US assets could just be an anomaly for 2013, we’ll have to wait and see. But it doesn’t give us confidence that the US government can keep borrowing money to prop the system up when the next slowdown hits.

It CAN keep issuing debt, but the Fed will have to buy the majority of it again, which won’t exactly be bullish for the US dollar’s role as the world’s reserve currency.

The can-kicking can’t go on indefinitely. Cracks will begin to appear in the system as the QE taper continues throughout 2014. Then the Fed will panic, and re-start QE or some other form of stimulus. But by this stage confidence will have taken a hit. It won’t be pretty.

We’re guessing (and it is just a guess) that all this will play out sometime in 2015. Whether we get a sell-off and then a speculative surge to new highs before then we haven’t a clue. Markets have no monetary anchors anymore, so volatility is to be expected.

Regards,

Greg Canavan+
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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5 Comments on "Losing Confidence in the US dollar"

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watcher7
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Greg writes:

“We’re guessing (and it is just a guess) that all this will play out sometime in 2015. Whether we get a sell-off and then a speculative surge to new highs before then we haven’t a clue.”

I would suggest that history provides the framework to see how the post-Cold War boom ends.

This short article, rather amateurish I admit, which I have referred to before, provides how history suggests things will play out:

The Greatest Bubble – and the Next Great Depression – http://www.members.optusnet.com.au/futurewatch/id120.htm

kees
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Phil Anderson wrote today that the US is doing great and the stock market is booming and will enter a double bull market (after a little correction, same goes for the housing market in the US. What do you think of his view, Greg?

Pl0ns
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..US gov and FED proclaims there is 59 months ( almost 5 years ) of constant grow – month by month. It makes it 3th longest grow in financial history..

There is “just” one issue – The debt has almost doubled at this time..

Kees,
You don’t have to be a rocket engineer to have a bit of common sense.

Jim scotland
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The us market for housing took its big hit 2008 , and if it fell 50 %then to come back to that high is along road back. Jim

Douglas Wills
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There will be a plague upon the land of unimaginable proportion. That’s what happens when too much borrowing finally causes a cataclysm. The whole US economy is a Ponzi scheme. Printing imaginary paper dollars at the discretion of a cabal of bankers (the Federal Reserve) to create a false prosperity never works. There is always a final reckoning that is inevitable. The entire world knows this and is abandoning the US dollar as fast as it can. The IMF recommends abandoning the US dollar as the world exchange currency. The US is no longer the world leader in anything except… Read more »
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