How long until the US dollar blows up?
Posted on 26 November 2008 with no comments from readers
Let me try to explain my thoughts in language that is understandable while not trivializing what is a very serious issue. We all know that the US dollar has been rallying sharply in recent months. Huge sell offs in global capital markets have created huge demand for the dollar and so its value has gone up.
At the same time interest rates have been falling on Fed funds, and the interest rates paid on T-bonds have headed to record lows. That in itself ought to be a warning to dollar bulls.
For most savers T-bonds are not attractive any more. They pay low interest rates, while banks are paying much higher rates on deposit accounts and in many countries there is now a state guarantee on those deposits.
Bond conundrum
Why would you hold a fixed-rate instrument like a bond – which can both fall and rise in value – when you could be earning more on a simple deposit account with a state guarantee, and have your capital at zero risk?
Individual savers have made this calculation and dumped bonds. Institutional investors and sovereign wealth funds have so far not done so, perhaps because bank deposits of this size would not be accepted.
However, the same investment logic applies to sovereigns as individuals. And this argument moves to being acutely important as soon as the T-bond’s currency starts to devalue.
Devaluation coming
Now with all these trillions of dollars being thrown into the global economy – and I saw $7.2 trillion as one figure for the total US bailout which I don’t think included yesterday’s $800 billion – devaluation can not be far away. Just as soon as these notional trillions enter the money supply as real trillions the impact will be huge.
That $7.2 trillion is half the annual GDP of by far the world’s richest country – how can you possibly inflate that much without impacting the currency’s value? Obviously you can not – and surely that means a strike by the buyers of T-bonds can not be far off. Who wants to buy a share of an asset that is collapsing in value? And once the T-bond buyers go on strike this is self-fulfilling.
So enjoy the strong US dollar while you can, it can not last and its fall will compound an already dreadful global economic situation. There I hope that is understandable. I hardly need to add that the only currency of choice is such an environment is precious metals.
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no Comments posted by readers:
what currencies will the dollar fall against? what currency will currency traders shift their money to?
Well, how about all the ones currently out of favor?
From the Daily Telegraph today:
Citigroup says gold could rise above $2,000 next year as world unravels
Gold is poised for a dramatic surge and could blast through $2,000 an ounce by the end of next year as central banks flood the world’s monetary system with liquidity, according to an internal client note from the US bank Citigroup.
By Ambrose Evans-Pritchard
Last Updated: 4:48PM GMT 26 Nov 2008
The bank said the damage caused by the financial excesses of the last quarter century was forcing the world’s authorities to take steps that had never been tried before.
This gamble was likely to end in one of two extreme ways: with either a resurgence of inflation; or a downward spiral into depression, civil disorder, and possibly wars. Both outcomes will cause a rush for gold.
“They are throwing the kitchen sink at this,” said Tom Fitzpatrick, the bank’s chief technical strategist.
“The world is not going back to normal after the magnitude of what they have done. When the dust settles this will either work, and the money they have pushed into the system will feed though into an inflation shock.
“Or it will not work because too much damage has already been done, and we will see continued financial deterioration, causing further economic deterioration, with the risk of a feedback loop. We don’t think this is the more likely outcome, but as each week and month passes, there is a growing danger of vicious circle as confidence erodes,” he said.
“This will lead to political instability. We are already seeing countries on the periphery of Europe under severe stress. Some leaders are now at record levels of unpopularity. There is a risk of domestic unrest, starting with strikes because people are feeling disenfranchised.”
“What happens if there is a meltdown in a country like Pakistan, which is a nuclear power. People react when they have their backs to the wall. We’re already seeing doubts emerge about the sovereign debts of developed AAA-rated countries, which is not something you can ignore,” he said.
Gold traders are playing close attention to reports from Beijing that the China is thinking of boosting its gold reserves from 600 tonnes to nearer 4,000 tonnes to diversify away from paper currencies. “If true, this is a very material change,” he said.
Mr Fitzpatrick said Britain had made a mistake selling off half its gold at the bottom of the market between 1999 to 2002. “People have started to question the value of government debt,” he said.
Citigroup said the blast-off was likely to occur within two years, and possibly as soon as 2009. Gold was trading yesterday at $812 an ounce. It is well off its all-time peak of $1,030 in February but has held up much better than other commodities over the last few months – reverting to is historical role as a safe-haven store
of value and a de facto currency.
Gold has tripled in value over the last seven years, vastly outperforming Wall Street and European bourses.