The Dollar Panic. Is it Real?

December 7, 2007 – This week as I was walking through the Houston airport, I glanced at a newsstand and noticed that the headlines of this weeks Economist magazine blared, “The dollar panic”. Normally, when an established magazine starts toting the death of the dollar, this event, combined with headlines of supermodel Giselle Bundchen demanding payment from American companies in Euros, would mark the bottom of the dollar and a time to buy into a dollar rally. However, this time is different. With firms like Goldman Sachs toting sustained dollar rallies as a possibility next year, these predictions are more likely the result of political agendas rather than reality.

If one looks at the long-term fundamentals of the dollar, there is nothing that supports the fact the dollar will have a long-term rally. Just as nothing rises higher in a straight linear path, nothing, not even the dollar, falls straight down either. Even when the long-term fundamentals are bleak, the dollar will experience some rallies. But that does not mean the dollar is turning the corner for a long-sustained climb higher. In fact, any decent rally is likely to trigger a stronger rally as a decent-sized rally would surely shake out many of the current enormous short positions, thus triggering a higher climb. Still this doesn’t mean, unlike the enormous consensus that exists today, that the dollar will strengthen for all of 2008. In fact, quite the contrary is likely to happen. Any short-term rally is likely to repeat the pattern of last May. Last May, 2006 the dollar had an eight-week run higher and the talking heads praised this run as a sign that the dollar was making a sustained turnaround. When the dollar strengthened in September and October of last year, again, the talking heads cheered the strength of the dollar. Of course, today, we all know that their rosy declarations were wildly out of tune with reality. Today, any long-term projections of sustainable long-term rallies (meaning months long or a year —long appreciation) in dollar strength are again, likely only serving political agendas again.

Pay attention to the underlying fundamentals – falling interest rates, a growing and already ludicrously enormous existing money supply, an inability to increase interest rates due to fear of creating a housing recession, unpegging of the dollar by gulf nation currencies, increasing demand of OPEC nations and non-OPEC nations of oil payments in Euros and Yen — all of these factors point to the fact that the dollar will not and can not experience a sustained rally higher. Study the ulterior motives of those propelling a sustained rally and you will understand the deceptive reasons behind their declarations. Goldman Sachs is one such entity predicting a sustained dollar rally for much of 2008. Consider that Goldman Sachs is just an extension of the U.S. Treasury with former Goldman CEOs repeatedly gaining the Presidential-nominated post of U.S. Secretary of Treasury, and there are obvious reasons why Goldman would want U.S. citizens to buy into the concept of a strengthening dollar throughout 2008.

To quickly dispel such notions, one only need look at the across the board failure of Wall Street’s top analysts to warn investors of the subprime crisis that destroyed wealth among stockholders of top American financial stocks. The very top analysts at UBS, Sanford Bernstein and Merrill Lynch maintained buy and hold ratings on such stocks as Bear Stearns and Citigroup during the entire time they were shedding as much as 20% to 40% of their share price. In two words, I would summarize those ratings as ludicrous and shameful. Yet, the foundation beneath the dollar is shakier than the problems that caused the subprime credit crunch, and the same shenanigans of “everything is alright” are being played out again like a broken record.

Think about how many times we, at maalamalama, have taken a stance exactly in opposition to the talking heads in the media and to Wall Street over the past couple of years, and think about how many times we have been right and how many times Wall Street has been wrong. The simple reason for this divergence is ulterior motives — Wall Street’s is to make money from gathering the largest volume of assets. Ours is to ensure that you maximize the returns on your assets.

Two completely different goals.

Again, you can’t judge us by what we are saying today because generally what we have to say is in direct opposition to the general consensus in the media. So do not take our word. Spend half an hour browsing through our blog archives and you will see that in our 15-months of archives, we have consistently predicted dozens of events that directly opposed mass investor sentiment at the time but came true three to six months later. And that is our point. In investing, you can not make money without having the foresight to see through all the white noise and nonsense that is presented to you today. Following this nonsense is what spurs investors to buy at highs and sell at lows. Sorting through the nonsense, is what allows you to consistently buy at lows and sell at highs.

The general consensus is that the Feds will cut interest rates at least by 25 basis points on December 11th. In fact, future traders have pegged the probability of a 50 basis point cut at almost 50% now after granting this occurrence just a 2% chance just a week ago. If either of these events happens, this means that the Feds will have cut the Feds Fund rate by 100 to 125 basis points in a relatively short time. Cutting interest rates expands money supply. Expanding money supply does not strengthen the dollar over the long term. Yet, analysts are saying that the dollar will rally over the long-term at the same time they are saying an interest rate cut will happen on December 11th. Does this type of analysis make zero sense to anyone else but me? It’s comparable to the Feds say that fighting inflation is their number one concern as they continue to slash interest rates and contribute to rising inflation in the United States. Their credibility goes right out the door.

Couple this information with the fact that Kuwait has already unpegged their currency from the dollar, Saudi Arabia has already “unofficially” unpegged their currency from the dollar, and long-term strengthening of the dollar is just not possible. Forget the fact that on Dec. 4, Qatari Prime Minister Sheikh Hamad bin Jassem al-Thani stated that leaders of the Gulf Cooperation Council (GCC) have decided to keep pegging their currencies to the sliding US dollar. This declaration was only made at the urging of Saudi Arabia and after Saudi Arabian Foreign Minister Prince Saud Al-Faisal stated that no public declaration of a plan of Gulf nations to unpeg their currencies from the dollar should be made for fear of creating, in his words, a dollar collapse. Remember that Kuwait unpegged their currency directly from the dollar just three weeks after they stated their allegiance to the U.S. dollar and that Saudi may have already “unofficially” unpegged their currency as well. If the U.S. Feds cut interest rates again on Dec. 11th and the central bank of Saudi Arabia fails to follow suit again, you can consider their unpegging official even with the lack of any “official” declaration.

The GCC’s public declarations of support of the dollar was more political than real, no doubt made at the urging of the U.S. government, even though such a statement will fool the masses into perhaps contributing to some short-term strengthening of the dollar. Already, the Gulf nations are feeling the painful consequences of their past secretive deal of trading currency agreements (agreeing to only sell oil in U.S. dollars) in return for military protection. Over the past six months, the Gulf nations have been among the few nations in the world to increase their holdings of U.S. Treasuries. These Gulf nation purchases were necessary to offset and compensate for the heavy selling of U.S. Treasuries by many Asian nations. Through the application of very heavy political pressure on the Gulf nations, the U.S. government can successfully transform political statements into official policy.

However, when push comes to shove, and maintaining the peg to the dollar causes raging inflation and severe economic pain to its own citizens, I believe that the Gulf nations will continue to “officially” publicly pledge to support the dollar while privately implementing strategies to unpeg their local currency from the dollar. Over the past six months, soaring oil prices are much more directly connected to a devaluing dollar than decreasing oil supply or peak oil. Had the Gulf Nations declared this week that they were going to unpeg their currencies from the U.S. dollar, I guarantee you that oil would have shot up beyond $100 to $120 a barrel within a matter of weeks. And that would have had nothing to do with supply and demand and everything to do with feared U.S. dollar weakness. Again, keep your eye on the real “unreported” fundamentals that surround the dollar to understand its long term fate, rather than being influenced by any “artificially-created” rallies that are simply unsustainable without extreme political maneuvering and barely sustainable even with the political acquiescence of Gulf nations.
[tags]death of the dollar, dollar crisis[/tags]

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