The Dying Dollar | Investing

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Since 2002, the US dollar has depreciated in value by a whopping 40%. The average Joe walking down the street still believes that the dollar that he earned 5 years ago is still worth a dollar. It isn’t – it’s lost 40%! For most Americans, until they travel abroad or go to purchase some imported products, they do not see the damage done to their currency. Those traveling, even across the boarder to Canada are shocked at how little their currency buys, even compared to a year ago.

In 2002, the Canadian dollar was worth about 63 cents US – today it is worth $1.00. What this means is in 2002 when an American traveled to Canada and stayed in a $200 hotel, he only paid $126. When he went out and had a very nice $100 dinner in 2002, he only paid $63. Today, should he be able to find a hotel room in Canada for $200, he will now pay $200. For that excellent $100 dinner, no longer does he pay $63, he pays $100.

The US dollar is crashing, the housing market is crashing, the Fed has slashed interest rates and is pumping billions into the economy. Up to now, the market has seen the decline of the dollar as being gradual and under control. But there is increasing risk that this decline of the US dollar could become out of control, causing sky rocketing prices.

The US dollar is the world’s reserve currency, meaning that everything is priced in US dollars. So when the dollar goes down in value, everything else goes up in price. One of the most incredible statistics that the US government releases is core inflation. Core inflation measures inflation minus a few items such as food and energy. Last time we checked, Americans still like to eat and turn the lights on at night - so the price of food and energy are rather important for the average American.

As we have seen, the price of oil has been steadily rising as the dollar has been steadily falling.
Commodities, hard assets are also rising. Looking at a chart of the Reuters commodity index we can see that the price of “stuff” keeps going up as the Fed floods the economy with money.

While all of this is going on, it is important to understand that in order to keep the US economy moving, the US has borrowed over $7 trillion from foreign investors and countries. In fact, the US needs to attract over $2.5 billion of foreign capital each day to keep the economy moving.

America needs to borrow from foreigners because Americans have become negative savers. In 2005, for the first time since the Great Depression, the personal saving rate in the US went negative, meaning that the average American spent more than they made – in 2006 it was worse. Over these past few years, Americans spent all of their savings and then borrowed money to buy houses, SUVs, new HD televisions, boats, cars – you name it.

The decline of the US dollar is accelerating largely because of the credit market crunch that we have well documented. The credit market crunch combined with the housing market problems, could result in a much bigger problem than we saw in the 2000 Tech Market bubble. In both cases we have seen the financial markets and policy makers very slow to see the risks.

Today’s problem could be more dangerous because the American consumer is coming under increasing pressure. The US economy needs the US consumers to consume. Currently, consumers account for over 70% of the gross domestic product (GPD). This has been a record level and if the consumers have to pull back, the economy could suffer a real slowdown if not a recession.

The US consumer, who on average has saved zero dollars, has been living on borrowed money. Much of that borrowing was made possible because of the rising equity Americans were seeing in their homes due to the housing boom. With housing prices leveling off and declining in many areas of the US, home owners no longer have the equity to borrow against – hell, many are having trouble making their new increased mortgage payments.

Given all of the above, foreign investors are becoming more and more uncomfortable buying US dollar-based assets and US financial instruments. This could kill an important inflow of capital, putting more downward pressure on the dollar. In fact, we recently saw where Saudi Arabia has taken the first step to unpegging its currency from the US dollar. Up to now the Saudi’s currency – the riyal – has been pegged to the US dollar. The Saudi monetary policy has mirrored that of the US. If the US raised rates, so did the Saudis.

Today, the Saudi money supply is a accelerating at a whopping 23% per year and inflation is running wild. So when the US dropped their rate by .50%, the Saudi’s said no more. They were not going to make things worse by lowering rates.

Earlier this year we saw Kuwait unpeg its currency from the US dollar, and now we have Saudi Arabia looking to do the same. The big concern now is that more and more countries will pull away from the US dollar. Remember that foreign central banks are a huge supporter of the US dollar – to the tune of over $3 trillion - and if they start unpegging from the dollar, then they would most probably want to unload a large chunk of that $3 trillion. This would be a huge blow to the US dollar.

Short term, we are expecting the dollar to rally some, mainly due to all of the bearish sentiment against the dollar today. When everyone agrees that the dollar is going down, we look for it to rally, to flush out some of that negative sentiment. Longer term, we are still bearish the dollar.

Those looking to protect themselves from the declining US dollar, there are a number of options:

Australian Dollar

Australia is a resource rich country and investors are also pouring huge amounts of money into Australia so the Aussie dollar is surging. You can buy the Australian currency through an ETF such as FXA.

Canadian Dollar

Same story as the Australian dollar – resource rich country. The loonie has been the strongest currency in the world recently. You can buy the Canadian dollar ETF with the symbol FXC.

Swiss Franc

We have done very well since we recommended buying the Swiss Franc in September. Although we expect to see a correction here in the next few weeks, we are bullish the Franc for the longer term You can buy the Swiss Franc ETF with the symbol FXF.

Japanese Yen

The yen is the most undervalued currency today.. International investors have borrowed an estimated $1 trillion in Japanese yen and put it into higher risk investments including massive amounts of mortgage-backed securities that are now being exposed. These investors are going to have to pay back these loans soon, meaning they will need to buy back the yen. You can buy a Japanese Yen ETF such as FXY.

If you do buy these currency ETFs, be sure to use sell stops. We will not be covering these in The Trend Letter other than to mention them occasionally. Stay tuned!

About the Author

Martin Straith is the editor of the TREND letter which is one of the most successful investment newsletters in publication.

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