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    Default The Late, Great American Dollar

    The Late, Great American Dollar

    Since the year 2000, we have witnessed the serious decline of the second greatest monetary brand in world history, the U.S. dollar.

    Two weeks ago, Federal Reserve Chairman Alan Greenspan urged the Bush administration to reduce the budget deficit and encourage more personal saving here at home. He said foreign investors were not likely to finance America's huge and growing trade gap forever, and he implied that if current trends continued, the U.S. risked a currency crisis.

    This is not the first time we've heard these warnings. But it is the first time we've heard them from Greenspan.

    Concern over the fate of the dollar is hardly new. The following prophetic comments were made by Teruhiko Mano, writing for the Japan Times in November 2000, when the euro was trading at 0.85 to the dollar—28% below the level it was at when the euro launched in January 1999, and more importantly (at least to those like myself who are beating themselves up now for not buying piles of Euro bonds at the time) when the euro was at its low point:

    "Since it would be too much to ask the U.S. dollar—the currency of a nation that has accumulated a gaping current account deficit—to cover the financial transactions of the entire world, we must realize that the euro, despite all its problems, is on its way toward becoming a world currency."

    Fast forward four years. Now you find Simon Brewer, Chief Investment Officer of Morgan Stanley, telling his clients at the Emirates Bank International's Al Shaheen Club dinner last month that he likes oil, gold, and Asian equities. And he hates U.S. equities and the dollar.

    What happened?


    Buddy, can you spare $20?

    First, a brief primer on currencies. According to commodities and money expert James Sinclair, a currency is valued by:

    — The reputation and financial acumen of management. This is expressed in a currency by the actions of the central bank, the quality and actions of the people in charge of the treasury, and the financial direction given by the country's political administration. This has a bottom line in the position of the federal budget in terms of the flow towards deficit or surplus.

    — Earnings, which are expressed in the Balance of Trade in terms of its deficit or surplus position.

    — The amount of shares outstanding, which in a currency is expressed by the Current Account of the country in question and its deficit or surplus position.

    — The "dividend" rate, which expresses itself in a currency in terms of the interest rate paid on six month money. Simply stated, if the interest rate paid on six month money exceeds the anticipated six month inflation rate, the impact is positive.

    Various items on a company's balance sheet, such as debt versus income, influence a company's stock price. Similarly, the balance of trade, the federal budget deficit, and the current account all influence the dollar's value. These factors are currently negative for the dollar, and they have been for a while. We now have a massive budget deficit, a negative trade balance, and a negative current account—and it's getting worse.

    Since Teruhiko Mano wrote his prophecy in November of 2000, the dollar has declined from 0.85 euros to 1.30 euros. As bad as that is, other countries certainly would have suffered considerably worse erosion of their currency value under the same conditions. So why has the dollar held up as well as it has?




    The dollar has been supported by our trading partners, especially Japan and China, by their purchase of U.S. Treasuries for the past several years. Why do they do this? Because if the dollar declines, imports become more expensive and Americans buy fewer of them. At the same time, U.S. exports become cheaper and U.S. voters sell more of them. Neither is good for China and Japan.

    But there's more to the unusual strength of the American dollar. Another factor that determines a currency's value is what I call "currency brand." Like any strongly branded item that's bought and sold, a currency's brand is built over a long period of time. Consistency and longevity of purchasing power build currency brand; inconsistency of purchasing power, or imbalances such as trade deficits, destroy it.

    The dollar is the longevity king of currencies. Since its inception, the dollar—unlike any other currency in existence—has never been cancelled. All Asian currencies, and all of the European currencies that preceded the euro, have at one time or another lost most or all of their value and then been cancelled and replaced by a new and improved version. If you held securities prices in that currency, they either lost value (as you traded them in at a discount in exchange for the new currency) or became completely worthless. By contrast, you can buy a dollar's worth of gasoline today with a dollar printed in 1900.

    But the dollar has seen some dark days. In the late 1970s and early 1980s, inflation ran over 10%, rapidly eroding purchasing power. The U.S. had to impose currency controls on its trading partners to slow the flight of capital. But trading partners forgave this as "management" (to use the analogy above), and eventually bit the bullet and adjusted policies so that the dollar returned to its previously stable state.

    Despite these episodes, the dollar's popularity has long trounced that of its European and Asian counterparts, which begs the question: if the dollar is the world's second greatest monetary brand, which is the greatest?

    As it turns out, Teruhiko Mano's November 2000 prophecy not only marked the best time to buy euro bonds, but also (not coincidentally) the best time to buy gold. A month before Mano's piece I wrote the following analysis, when gold was trading below $270 per ounce:

    "One can buy physical gold now for around $270 and have gold provide the same 'fundamental strength' to one's personal balance sheet as it provides for the IMF's. But as a long-term investment I conclude that its value is far more doubtful. Long term, one is best off owning an index of stocks that will tend to grow in line with the world economy, an inevitability in spite of occasional setbacks.

    Still, it's hard to go wrong with a small gold bullion position. Gold is now trading near 13% of its inflation-adjusted peak price of $1,937 (in year 2000 dollars) whereas U.S. stocks as a class are trading at a premium never before seen, even after recent declines. It's possible that the price of gold will fall the remaining 13% to zero and the DOW will explode to 36,000 in the next few years as some predict. But is the collapse of the price of gold the remaining 13% toward zero more or less likely than a return of stock prices to their mean P/E ratios and a counter-cyclical return of the price of gold toward a (DOW/gold) price ratio closer to one to one from the current ratio of 37 to one?"

    Gold has risen by 66% since I first penned the above analysis, to $448.20.

    A very old money brand, gold, and the new monetary brand, the euro, are getting stronger, as the dollar brand continues to weaken. This trend will not change unless politically painful choices are made by management to support the value of every dollar ever printed.
    (This article originally published on the AlwaysOn Network August 30, 2004.)

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    Last edited by EJ; 02-21-08 at 02:52 PM.
    Ed.

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