Greenback Slumped on the Canvas

By: Prieur du Plessis | Fri, Dec 19, 2008
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Bernanke & Co. on Tuesday signaled to the financial markets that they were hell-bent on pursuing an "inflate or die" approach to rescuing the ailing US economy and fending off the forces of deflation. The Fed is now inflating at a level possibly not seen before by a developed nation since Weimar Germany.

Since the credit crisis started intensifying in July, the dollar benefited from a global flight to safety in US Treasuries and a scramble for dollars to repay USD-denominated debt. The deleveraging process effectively created a short position in the greenback.

But more recently, US-specific worries concerned with public debt expansion and the potential inflationary implications of quantitative easing dawned upon battle-weary investors, causing the dollar to reverse the uptrend that had commenced in July.

The US Dollar Index (i.e. a trade-weighted basket) has not only breached its 50-day moving average convincingly, but seems to be forming a top of at least medium-term significance (see chart below). The fall from grace was brutal with the Index recording its largest six-day decline (from December 10 to 17) ever, setting up an assault on the key 200-day line (often seen as a crude indicator of the primary trend).

The US currency also suffered its biggest one-day slide against the euro on Tuesday, and plunged to a 13-year low against the Japanese yen. (Also see my weekly "Words from the Wise" review for comments on currency movements.)

The table below shows the performance of the US Dollar Index, as well as a number of major and emerging-market currencies against the US currency. Gains against the US dollar (green) / losses (red) are given for (1) the period since the dollar's high of November 20, (2) the period from the dollar's July 21 low until the November high, and (3) the year to date.

The devaluation of the US dollar de facto exports deflation and depression, raising the question of how long it will take before other countries retaliate and embark on "beggar thy neighbor" currency debasement. China is already in the process of "managing" the renminbi lower, Russia's central bank has signaled it would step up devaluation, and the Bank of Japan and others might also consider intervention.

"Either we are going to pay for our policy sins via higher interest rates or a weaker dollar. And for an economy that is as levered as the one in the US is, the former choice is not an option," said Stephanie Pomboy (MacroMavens). "So a weaker dollar is the natural valve."

US creditors - such as China - with large hoards of dollars are growing increasingly nervous, and the dollar is likely to come under additional pressure if foreigners stop finding dollar assets an attractive proposition. The only way the US can attract foreign capital is by offering a higher interest rate or making its assets cheaper through a weaker currency.

Jim Rogers commented as follows in a Bloomberg interview: "... the dollar is a terribly flawed currency. I hate to say it, but my goodness, they've messed up the dollar badly. So, I don't like to do it, but I'm going to sell all the rest of my dollars sometime in the next few days, weeks, or months ... Again, I don't like saying it, but I'm afraid the dollar is going to go the way the pound sterling went."

The speed of the dollar's decline has been such that it is quite likely to see a relief rally before the downtrend resumes. Arguing for a temporary hiatus from a fundamental viewpoint, Stephanie Pomboy said: "... right now, we are enjoying some real competition in the ugly contest from the currencies of the European Union and the United Kingdom, and that will probably persist for a while because they are in pretty bad shape, and they are a little bit behind the curve relative to us."

Lastly, a sustained break in the uptrends of the US dollar and the Japanese yen - low-yielding currencies previously used for funding risky investments - should indicate that forced selling due to deleveraging is starting to subside. As this situation plays itself out, we should see a return of confidence and a calmer period for stock markets in general, and also some support for precious metals and commodities. The dollar may be down for the count, but could herald a sense of normalcy in broader markets.

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Prieur du Plessis

Author: Prieur du Plessis

Dr Prieur du Plessis
investmentpostcards.com

Dr Prieur du Plessis

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

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