Is the US dollar going up or down, hedge your bets?

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The opinion of currency analysts on the immediate outlook for the US dollar is almost evenly divided between two extremes: those who think the dollar will rise significantly in value by the end of the year; and those who conclude that the greenback will fall.

It is a pretty fundamental disagreement among folk paid a great deal of money to get these things right. Why then is there no consensus on this vitally important matter?

Government intervention

The main problem appears to be in deciding how the bank bailouts and stimulus packages will impact on the US dollar later this year. Let us look at the two sides of this argument.

If the bailouts and stimulus measures do their work then the US economy will continue to recover from the tentative bottom we have reached today, and it will recover ahead of other nations. Ergo the dollar will rise in value relative to other major currencies.

This argument could also work in another way: if US markets crash over the summer or into the autumn then a big sell-off of stocks will mean a major shift into the dollar, and rally the currency higher, even when the stock market and economy are tanking.

The converse argument is that the 10 per cent rise in the M0 money supply this year is setting the US economy (and others that followed its example) for a sudden burst of inflation. This would be received negatively by currency markets that would mark the dollar down against less inflated money supply currencies.

Confusingly this argument might well also apply in the case of the recovery scenario, thus upsetting even the most optimistic forward view of the US economic outlook.

Buy or sell?

Observers can be forgiven for not knowing whether to buy or sell the US dollar with this divided and polar advice. The obvious rejoinder is to consider economic prospects in other major economies, but again this does not help much.

Japan looks in worse shape than the US, the UK too, and the euro-zone has plenty of icebergs buried in its banking system. So if the dollar is to devalue it is far from clear against which currency it might do so, except commodity currencies that do not have fixed pegs to the US currency or precious metals.

Hence one way to sit on the fence would be to hedge dollar exposure with precious metals or commodity currencies. Certainly diversification is a tried and tested strategy for dealing with uncertainty.