The Dollar is Dead Meat

Bill Bonner - Mon 16 Nov, 2009

In the short run, it might have enough life in it to bite investors on the derrière

London , England

We got back from South America on Friday... ready for a rest. So, we spent the weekend reading... and occasionally, thinking.

What we’ve been thinking is that the dollar is dead meat in the long run. But in the short run, it might have enough life in it to bite investors on the derrière.

The US stock market rose 73 points on Friday, to bring the Dow just 30 points south of the 10,300 mark. Why is this level important? It’s not really. But it reminds us that this is still just in “bounce range.” Big drops in stock prices are followed by bounces – always. A bounce of 50% of what was lost is not unusual. That’s what happened after the Crash of ’29, for example. So, there’s nothing exceptional about what we’re seeing on Wall Street.

But here at the Daily Reckoning we’re not smart enough or fast enough to play the countertrends. We want investment positions that we can ignore for years... We want to be able to go on a long trip... say, down the Inca Road or over the Hindu Kush. And when we come back, we want to find that we have at least as much money as when we left.

If stock market buyers – in the US – have more money a year from now than they have now, we’ll be surprised. The private sector is still more than 2/3rds of the economy. And the private sector has begun de-leveraging. Nothing that has happened in the last 8 months makes us think that that trend is going to reverse any time soon. There are 70 million baby boomers who need money for retirement. They’ve got to save. That means cutting back on spending. And that means less income for business. Are stock prices really going to go up when business income is going down? No.

We leave our “Crash Alert” flag flying, here at the worldwide headquarters. We don’t know when... or IF... stock prices will crash. But the downside risk is not worth the possible upside. Daily Reckoning readers should be out of all US stocks, except those they wouldn’t mind holding through a 50% correction.

The other thing we mistrust – aside from politicians, stock promoters and tap water – is the dollar. But here the story is more complicated. Because the next downswing in stocks could push the dollar up! Everyone is betting against the dollar. And most think it is a one-way gamble. But it’s not like Mr. Market to grant investors a one-way bet. He’s got something up his sleeve.

Last week, the Financial Times reported that a group of IMF economists had made a “Plea to reduce demand for dollar reserves.”

That is another way of saying: find something else to put in your vaults rather than dollars!

Why? Because a world money system that uses dollars as a reserve currency is fragile and vulnerable. It makes the whole world hostage to America’s financial problems.

“The US, at the center of the system, was under pressure to run large current account deficits in order to supply the world with the dollar assets it wants, they said, while there was no effective discipline on either the US or countries such as China that have big external surpluses to adjust their policies.”

This move by IMF economists is only the most recent effort to reduce the world’s reliance on the dollar. Everyone can see the dollar is weak. And everyone with any sense wants to protect himself from it.

On Friday, the price of gold moved up to $1,116. Gold is the obvious choice for those who wish to protect themselves from the dollar. But readers are cautioned: that doesn’t mean the price of gold is going up.

Over the long run, sure. All paper currencies eventually go to their intrinsic value, which is zero. And gold always goes to its traditional value too – at a level where a man can take an ounce of it and get himself a suit of clothes, about 30 bottles of good whisky... one horse... or a trip across the Atlantic in economy class.

But things that ought to happen do not always happen when you think they should. It could take many years – of long, drawn-out recession... à la Japan – before the Bernanke Fed gets its helicopters revved up. In the meantime, all those hot shots who borrowed dollars from the Fed in order to bet against the greenback are going to be in trouble. They’ll have to unwind their carry trade positions at a loss... and pay back more expensive dollars. The process could take years.

More news… how the “short-term bad behaviour of the market” spooked this investor…

Here’s a mystery.

A subscriber to Research Investments, one of our most successful investment services, wrote in to cancel. He wasn’t happy with what he had received and was taking up his right to get a refund.

No problem at all. All our subscription services have a three-month period in which we give readers all the current share recommendations and other research to review. They can invest in the companies we tip or just see what they think of our research for a three-month period. If they decide that – for whatever reason – the service is not right for them, we will refund their subscription fee.

Not only that, but they get to keep whatever we send them. We like to think that’s a fair offer. And it gives people the confidence to try our services. They get three months to see what the service is about… and see how it has been doing. We’re confident readers will like the depth of analysis and the ideas we write about. If so, and they go on to make good returns, we believe they’ll stay with us a long time.

So managing editor of Research Investments, Frank Hemsley, had no hesitation in agreeing to our valued subscriber’s cancellation request. But of course, he was keen to know exactly where the reader felt we had let him down.

Well it turned out that after receiving the initial material upon joining the service, our reader bought £10,000 worth of shares in four of the companies recommended.

They all went down.

“I know I didn’t give them more than a few weeks” , explained our cherished reader, “but, at the time, it made me think it was a scam so I sold them. Looking back, I should have bought just one share and followed it. I now realise I do not trust anyone’s judgment other than my own and would not heed further recommendations.

“I suppose I will have to say that it is not what I'm looking for. I think the various financial scandals of late has made me very suspicious.”

Well it’s a shame that our reader felt that he couldn’t trust us. We like to think that our long-standing good reputation amongst private investors would have preceded us, but not so in this case.

This reader was clearly spooked by the short-term bad behaviour of the market. And we cannot help but wonder how his investments in those four companies would be doing now, had he stayed on.

“At today’s prices,” notes Frank Hemsley, “these shares are up 80%, 13%, 43% and 4% from when they were first recommended. But it’s the long-term performance that is what we’re interested in. And we think these all have a long way to go.”

Investment is not about making snap decisions. You need to think things through. Buy companies you like and buy them with a goal in mind. Don’t expect them to pay-off overnight. Don’t be surprised if they go down overnight. Just focus on the longer term.

This is what Research Investments is supposed to be about. It’s just a shame that our dear reader didn’t give it a chance.

We have cancelled the reader’s subscription and arranged to send him a full refund. Of course, we’d have him back without hesitation if he decided to give the service a little longer, and Frank has extended that invitation. We’re confident that he’ll make outstanding returns over the long term. But that’s his decision to make. The door is open…

Research Investments is currently not taking on new subscribers. But it is available to people who join our very small membership “elite investor Alliance ”, something our reader might find appealing.

Frank Hemsley explains: “This gets you our top 6 newsletters (Research Investments, The Fleet Street Letter, Red Hot Penny Shares, The Bulford Files, The Zurich Club and Profit Hunter) for as long as we publish them for a substantially discounted upfront fee.

“This package is worth £1,644 per year if you were to pay the normal subscriptions to these 6 services. However, by joining the Alliance , you get them “for life” – i.e. as long as they are published – for a one-off fee of £2130 plus a small admin charge.”

That is incredible value and it’s an offer that we rarely make.

If you’d like to take advantage of it, you have just THREE DAYS until the doors close. After Thursday, you will not be able to get this deal. We urge you to read this now and see how it can help you.

Click here for a letter explaining all the benefits.

Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.

And back to Bill with more thoughts...

*** The US now has the highest unemployment rate of all major economies. Even France – historically, an economy with high jobless rates – is at 9.5% unemployment, while the US is 10.2%.

As for inflation, the lowest inflation rate among the world’s larger economies is in – you guess it – Japan. After 20 years of on-again, off-again deflation, it’s on again in Japan... with inflation at NEGATIVE 2.2%. But inflation is negative in the US too – at minus 1.3%.

Both Japan and the US claim positive GDP growth, compared to Europe, which is still in recession. But throughout the world – except perhaps for the BRIC nations – growth is weak and hesitant.

The US and the UK are both consumption economies. No consumption; no growth. But how do you get people who’ve consumed too much to consume even more? They know they can’t afford to keep spending. And they know that going further into debt just makes the situation worse. What can you do?

You bribe them!

You give them more money, say, in unemployment assistance. Or, you give them a tax credit when they buy a new house. Or, you give companies a big tax break. In the most recent stimulus bill, for example, the feds do all three – including giving Pulte Homes a $450 million tax refund.

Here at the Daily Reckoning we never met a tax cut we didn’t like. But with the deficit at 13% of GDP, we might make an exception. One way or another, someone’s going to have to pay for the feds’ big spending stimulus efforts. Taxpayers. Bondholders. Dollar holders. All of the above.

President Obama told the crowd in Singapore this weekend that he would make sure Ben Bernanke stayed away from his helicopters. The Chinese are the biggest holder of US bonds in the world. The Japanese are next. Between the two of them they fund a big part of America’s current spending. Naturally, America’s president is eager to keep the cash coming his way. So he has had to reassure the nation’s largest creditor that their loans to the US will be repaid in good order... and good currency.

China alone has $2.3 trillion in reserves... most of it in dollars. Of course, the Chinese want to diversify out of greenbacks. But they’re caught in a trap of their own making. If they turn away from the dollar, they undermine its value... and the value of their own reserves. What’s more, America is still China’s number one customer. They need to sell to America. And for that they need to keep their own currency from rising too much against the greenback. A higher yuan makes their products relatively more expensive compared to other exporters.

So, the infernal system continues... America creates dollars. The foreigners take them as though they had value. And they will have value... as long as they take them.

*** In the ‘90s and ‘00s the newspapers were full of stories about what a great place America was. Its economy was so dynamic... its entrepreneurs were so clever... its financial system was so highly evolved and flexible. What could go wrong?

Everything!

And now we’re going to read a lot of claptrap about what an awful place it is.

“The American dream needs repair,” is forerunner of the genre. In today’s Financial Times, it focuses on the rigidities of the US system. The time was when a young American could start at the bottom and work his way up. Luck and pluck was all that it took. But now, according to scholars at the Brookings Institution, people stay put. If you’re born poor in America you’re more likely to stay poor than if you had been born poor in Britain, Denmark, Sweden or dozens of other countries.

What happened? The authors do not say. So we will. Success breeds failure. As a society becomes rich, more and more people find ways to game the system. The elite get tax credits, tariffs, and protective regulations. Every layer of bureaucracy makes it harder for new competitors to get ahead. And every new tax on income makes it harder for upstarts to join the ranks of the rich. The poor get their parasitic benefits too. Welfare, unemployment compensation, child tax credits, medicare, food stamps, social security – all of these programs give the poor an incentive to stay poor.

*** We spent the weekend reading. One of the books we read was Malcolm Gladwell’s “Outliers.” Typically, Gladwell tells a good story, makes some interesting comments, and misses the point. “Outliers” is no exception. He describes how some groups came to America as immigrants and made successes of themselves. The Jews, for example. They arrived penniless in New York. The first generation started small enterprises. The second generation turned them into big enterprises. And the third generation became lawyers, judges, doctors, and Nobel Prize winners. He cites this example with approval. They made good, he seems to say.

We’re not so sure. What we see is a class of people switching from free-wheeling enterprise to highly regulated, status-oriented professions. The next thing you know, they’re on Wall Street. Instead of adding value as merchants and manufacturers, they’re subtracting it with mortgage backed derivatives.

Until tomorrow,

Bill Bonner
For The Daily Reckoning