Tax & Financial Consulting Services
Dollar to Rally in 2010
Imhotep (Wisdom To You) GGIS Subscribers,
“Under a paper-money system, a determined government can always generate higher spending and hence positive inflation by increasing the number of U.S. dollars in circulation.” — Ben Bernanke speaking at the National Economists Club back in 2002.
The printing press has become the Fed’s best friend since the start of this crisis in 2007. No wonder dumping the dollar became so popular. But something has changed in the last few days. The dollar downtrend that started in March is running out of steam.
Although there are very good reasons to hate the dollar, in the currency world everything is relative. Recent events are showing that other corners of the world, such as the euro zone, Japan, and U.K., may be facing bigger challenges than the U.S. Recent economic data, such as unemployment and retail sales, has also been surprisingly positive. So the dollar is getting some support from improving fundamentals. But can the dollar continue strengthening going into 2010? I believe so.
But rather than fundamentals, I think risk-aversion will play a more important role in supporting the dollar. As confidence in a quick economic recovery increases, so does the risk of a correction in the stock market. Who will buy stocks after everyone has turned bullish?
This year the excessive optimism about a quick recovery will be laid to rest when the market realizes that years of reckless credit growth cannot be resolved quickly. The reluctance of banks to lend will continue because they know there are more defaults coming. Double-digit unemployment rates will linger for some time, and corporate earnings will disappoint.
In China, loose lending policies will increase the risk of asset bubbles and inflation, forcing their central bank to unwind some of their extraordinary liquidity measures. Other central banks around the globe will also start implementing exit strategies, which will be one more risk event supporting the dollar.
So if the dollar will strengthen, how will the other three major currencies fare next year?
U.K. Up to its Neck in Debt
The British pound, like many other currencies, has appreciated substantially against the battered dollar in the last few months. But there are already signs that the U.K.’s economic recovery is fading. So the Bank of England (BOE) will have good reasons to keep rates low for a long time, disappointing those who are expecting rate hikes and a stronger pound.
The U.K.’s debt is already 69% of GDP — nearly double the 35% of GDP at the start of the housing crisis in 2006. It’s on track to head to over 80% in 2010, which will send most investors scrambling for a safer currency.
Due to the country’s rising debt burden, the rating agency Standard & Poor’s has already lowered the outlook on the U.K.’s AAA rating to “negative.” And other rating agencies have recently warned that they won’t hesitate to downgrade its debt if the fiscal situation continues to deteriorate.
Japan: Two Lost Decades (and Counting…)
Can you imagine if you had to use 26% of your income to make interest payments on your debt? That’s what Japan is facing. The country is on the path of stealing the title of most indebted nation on the planet from Zimbabwe. In fact, if I had to describe Japan in a few words, I would describe it as a debt-deflation minefield.
The latest annualized GDP numbers were revised down from 4.8% to 1.3%. That sounds like a joke to me, but it shows why a double dip recession is just around the corner. The Japanese government is so desperate that it has recently launched a new stimulus package. But the problem is that it has been doing that for a long time without any success.
Since 1990, Japan has implemented 10 fiscal packages. And what are the results? A stock market that is still down 80% from its peak in 1990, and an economy that seems to be in an endless recession. With such horrible fundamentals, the dollar carry trade is the only thing that’s keeping the yen from weakening. Short-term rates in America are lower than in Japan. So it’s now cheaper to borrow the U.S. dollar than the Japanese yen.
Europe in Intensive Care
The euro is also set to fall next year. The flaws of the European Monetary Union are already becoming more evident. During 2008 the European Central Bank rescued weak economies by making liquidity available through cheap funding. But the European Central Bank has already announced that “excessive liquidity provisions will have to end.” When that happens, institutions and countries will have to look for funding at market rates. Banks with weak balance sheets, and countries with unsustainable levels of public debt, such as the PIGS (Portugal, Ireland, Greece, and Spain), will face higher funding costs. That will raise uncertainties within the euro zone, putting pressure on the euro.
Higher funding costs will increase deficits and debts at an even faster pace. This cycle can be very dangerous and can easily lead to further downgrades from rating agencies.
Bottom line: the euro will depreciate dramatically because of euro zone’s sovereign debt problems.
How to Play the this Dollar Rally
An easy and conservative way to profit from a dollar rally is through the U.S. Dollar Bullish ETF (???). Become a G&G Investment Society (GGIS) to get the investment pick that will take advantage of this Short Term Dollar Rally!
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This ETF is long the U.S. Dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. It also serves as a hedge in case of a major correction in the stock market (This means the stock market declining, so watch out if 401K plans, Pension funds, TSP accounts). However, trading currencies in the spot market offers far more profitable opportunities, especially in the area of exotic currencies.
If you would like more information on this, contact me at GGIS@gngassoc.com and I’ll show you how.
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Click on link for this month’s article to see what you are missing:
GGIS Portfolio Update (Jan ’10): http://www.gngassoc.com/pdf/GGISJan10.pdf
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Asante Sana (Thanks)
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