Thursday, October 22, 2009

Dance of the Declining Dollar Continues

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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The trade-weighted dollar fell below 75.00 yesterday, only seven trading days after it decisively broke 76.00. It is up above 75.00 this morning and should have a short rally at some point soon because it is too far below its 50-day moving average. Any recovery will only be temporary however. Selling pressure seems to never be far away. The short-term rallies have the signature of some form of government intervention. They are sharp, sudden and tend to take place after some support level has been broken and when trading in the U.S begins. Once the intervention money runs out however the dollar just continues its downward drift.

Manipulating a major currency is an expensive undertaking and requires a lot of resources. The size of currency markets is huge compared to the bond market, which in turn is huge compared to the stock market. Direct intervention requires using foreign exchange reserves. The U.S. has almost none of these. Late July figures from the Treasury website indicate that the U.S. has only a net $7 billion in reserves (foreign currency holdings minus short positions). This would be appropriate for a small developing economy, not a superpower. In contrast, China has approximately $2000 billion in foreign reserves. All the big holders of foreign reserves hold large amounts of U.S. dollars. Their intervention in the currency markets would require they buy even more dollars with their other more desirable reserves in euros, yen, pounds or other currencies. This would not be a good deal for them.

Significant intervention to hold up the dollar will be occurring probably next year. There has been a history of such interventions in the post World War II era. Their effect is only short-lived unless the underlying condition that caused the currency weakness in the first place is corrected. In the current case, the U.S. needs to raise interest rates to attract dollar investments. The actual condition of the U.S economy (not the phony PR about the recovery) makes this impossible for the next many months. It is possible though that an extreme drop in the dollar may force the Fed's hand next spring.

Whether the dollar just continues its slow agonizing fall, which has become a fixture since the U.S. left the gold standard in 1971, or whether there are some serious short term declines (this happened through devaluations in the 1970s) remains to be seen. This fall may be the first time one of these sharp, sudden drops takes place.

NEXT: In for a Penny, In for a Pound

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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