The Coming US Dollar Implosion

When dealing with real estate investments, the rule is location, location, location. With regard to investments in general, the rule should be TIMING, TIMING, TIMING. The reasons are self-evident. If one is too early or too late, the results are disastrous. There are, however, "points of recognition" in any market move which, if acted upon, remove a great deal of the risk and vastly improve the timing and profitability of one's investment activities.
There is a high probability that an implosion is coming in the US dollar, but before detailing the reasons why this should be so, let me give the likely "points of recognition". These benchmarks, when exceeded, will result in a change in the perception of the majority of investors to the point where they realise that the trend has changed. For the US dollar these "points of recognition" are a rise by the Euro to above US96c and a fall by the US dollar index to a level below 108. These points are derived from technical analysis and will be confirmed by most technical analysts. It is unlikely that you will be reading this article if the US dollar has not already exceeded the "points of recognition" of US96c for the Euro and the 108 level for the US dollar index. I do not expect to hit the "Send Messages" button and publish this article until those "points of recognition" have been surpassed.
Why is there going to be an implosion in the US dollar? For the past 31 years, since the USA closed the "gold window" and the world embarked upon a worldwide experiment in fiat currencies (money created by Government decree), the world has existed on a US dollar standard. Every prior experiment with fiat currencies throughout history has ended in disaster because Governments could not resist creating ever-increasing quantities of their fiat currencies, to the point where citizens lost confidence in those currencies.
In this, the world's first ever experiment in worldwide fiat currencies, the US Dollar has been the lynch-pin. It has been the currency that other countries have been prepared to accept as a "standard", as a store of value. The result of this universal acceptance is that the USA has been exempt from the disciplines that are automatically imposed upon other countries. If country "X" runs a trade deficit, it has to somehow achieve a capital inflow to counter balance the trade deficit outflow. It generally does this by a combination of currency depreciation (which gradually assists in eliminating the trade deficit), higher interest rates or foreign borrowings. In the case of Argentina, they linked their currency to the US dollar.
When Argentina started running trade deficits, instead of depreciating their currency, they opted for retaining the dollar link and resorting to foreign borrowings to cover their trade deficit - until they got to the point where foreigner lenders said "No more". Now their currency has been forced to depreciate by 66% in a few months and they are still trying to deal with the necessary social and banking adjustments.
The only country exempt from this discipline is the USA because foreigners have been satisfied to accept US dollars when they have trade surpluses with the USA. Thus the USA has been able to run a trade deficit for years and pay for it in US dollars. It doesn't take a rocket scientist to figure out that this trend is unsustainable. At some point foreigners will either lose confidence in the US dollar or be unhappy to purchase US assets with the surplus US dollars that they accumulate or, worse still, both. At this point there will be an implosion in the US dollar, the mechanics of which are explained later.
Which brings us to the inevitable point of TIMING. This situation of a possible dollar implosion has existed for years. Why should it have relevance NOW?
There are a number of reasons, probably the least of them being the ongoing US trade deficit that is running at US$32 billion per month or over US$1.0 billion per day. It means that each day there is US$1.0 billion that requires someone to make a decision upon. Do they want to hold US dollars and US dollar assets? The two are inseparable. Someone holding US dollars is obliged to make an investment in US assets. So the question really is: how good are investments in the USA at this time?
This is where foreigners strike some real problems. Equities on the US stock market are at historically high PE ratios, some 3 times above the norm and twice the level of PE ratios on foreign stock markets. Then there is the problem of accounting for profits. Are the already high PE ratios realistic? Should they not perhaps be even higher when proper accounting systems are applied?
These ultra-high PE ratios can only be cured by either: (i) a very sharp rise in corporate profits; or (ii) sharply lower share prices, or (iii) a combination of these two options. Whichever way one looks at the problem, US equities do not look enticing. Interest rates in the USA are near all time lows. The next sustained move in interest rates will almost certainly be upward, which will be seriously bad news for the bond market.
Real estate is very frothy and looks as if it could be at a peak. Can one really risk an investment in US real estate, especially with a rise in interest rates in prospect? Even US bank deposits yielding less than 2% are unexciting. This is why the "points of recognition" on the US dollar become so important. Once these points are exceeded, most people will be convinced that the US dollar is in a down trend. This is when foreigners will have to seriously consider what to do with their US dollar based investments.
Foreigners will, firstly, consider how far the dollar will depreciate against their home currency over the next 12 months. Could it be a 10%, 20%, 30% or 40% drop? All of these levels are possible. Assume that a foreign investor thinks that the US dollar will decline 20% against his home currency, then the question is: "Can USA assets rise by 20% to compensate for the currency loss and leave the investor in a level, no win, no loss situation?" The answer seems to be a clear "No".
In these circumstances, it is logical and reasonable to anticipate that the foreign investor will conclude that the sensible option is to liquidate the US investments and repatriate the funds into local currency assets or assets in another currency which is firming against the US dollar.
The nightmare begins.
Foreigners own over $8.2 trillion of assets in the USA. If foreigners holding just 20% of this total decide to liquidate and take the money home, that means some $1,640 billion of US assets will be sold and the proceeds transferred into foreign currencies. Add to this the annual trade deficit of $360 billion that also has to be financed and the imbalance in financial and foreign exchange markets becomes obvious. A small matter of $2.0 trillion trying to escape the US dollar!
The nightmare gets worse.
If it is reasonable and logical for foreigners to sell their over-valued US assets and send the money somewhere else, then surely it must make equally good sense for American investors to do likewise? And American investors own a much bigger slug of US assets than foreigners do. It requires only a small fraction of US investors to decide to move off-shore and their funds will far exceed the amount that foreigners try to move.
And it is not over yet. There are many extremely intelligent hedge fund managers who are desperately looking for a good deal to reward their investors. Borrowing US dollars and investing in foreign assets must be the next big "play". Some of them will even figure that the big winner in this whole situation will be gold as it is the ultimate money, the "final store of value". Most other currencies are suspect because they are all worthless paper. In these circumstances a dollar implosion is a very high probability event. It is a question of "WHEN" not a question of "IF".
This is why the two levels that I mentioned - the Euro at above US$96.0c and the US Dollar Index below 108.0 are so important. Electing these levels will signal that the US dollar trend has turned firmly down. You will only be reading this article if those levels have already been exceeded. Once the dollar has surpassed these two "points of recognition", the "WHEN" will have become "NOW".
One only needs to look at the Japanese Yen for confirmation. The Japanese are printing the Yen into oblivion in order to keep the currency weak and thus protect the Japanese export industries. Despite this wholesale printing, the Japanese Yen has been rising against the US dollar! What does that tell one about the current status of the US dollar? Perhaps the Japanese should employ some ex-Arthur Andersen partners who have demonstrated an ability to destroy paper.
While gold will almost certainly be the top investment in this climate of a sharply declining US dollar, the Euro and Swiss Franc may also be strong beneficiaries because these countries have large gold reserves. At some point in the future they will have the ability to restore gold convertibility to their currencies, albeit at a very much higher gold price. Secondary beneficiaries will be the currencies of those countries that produce gold, notably Canada, Australia and South Africa.
Alf Field
PS :The closing price for the Euro tonight (20 June 2002) in New York is US96.51c while the US Dollar Index closed at 108.94. Thus the Euro has surpassed its "point of recognition" while the Dollar Index within a point of doing so. It seemed appropriate to click on "Send Messages".
AF June 20, 2002
Disclosure and Disclaimer: In the interest of full disclosure, the author advises that he is not a disinterested party in that he has personal investments in gold and silver bullion and in a selection of gold and silver mining shares. The author's objective in writing this article is to invoke an initial interest on the part of potential investors in this subject to the point that they are encouraged to conduct their own further diligent research. Neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock or commodity. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions. >


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