Thursday, October 8, 2009

Desperation Time for the Dollar

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The U.S. dollar gapped down this morning to 75.90, falling below the critical support level of 76.00 (for the second time). It quickly shot up to just above 76. Gold and silver were up nicely overnight with gold reaching $1059.60, another all time high. Silver traded as high as $17.86. Both dropped sharply when futures trading began in New York on COMEX. The not so invisible hand of the U.S. Treasury is evident in both precious metal and dollar trading this morning. The bill for the money printing free lunch may be coming due sooner than U.S. officials thought.

Rumors are that central banks in smaller Asian countries are buying dollars in a desperate attempt to keep their currencies from rising and damaging their export businesses. Central bank buying of a currency indicates downward market pressure has gotten out of hand. The tipping point may have come when Australia raised its interest rates a few days ago. A carry trade already existed for the U.S. dollar and the Australian central bank action may have opened the floodgates. A carry trade is when traders borrow money in a lower interest rate currency and use that money to buy a higher interest rate currency. Money is made on the interest rate spread. So traders borrow in dollars at short-term rates around zero and buy Australian dollar denominated short-term debt at 3.25%. The carry trade can become a bubble feed back mechanism that causes the low interest rate currency to continually spiral downward and the high interest rate currency to spiral upward. With the exception of Japan, almost every country in the world has higher interest rates than the U.S.

Any central bank intervention will only pause this problem however, it won't solve it. The only viable solution is for the U.S. to stop printing money and raise interest rates substantially. If a real economic recovery is taking place in the American economy that is actually what would be happening. If the U.S. government is lying about the recovery, interest rates will not be raised for some time. The latest statements from the Federal Reserves is that its low interest rate policy will be maintained for quite awhile... and for good reason. Australia can raise interest rates because its commodity-based economy is actually getting better. Australian unemployment is 5.7% and falling compared to the U.S. rate of 9.8% (17% in the alternate figure the government publishes) and rising. You should ask yourself, "how come unemployment goes down when the Australian economy recovers, but not when the U.S. economy 'recovers'?"

The lie was further put to the U.S. 'recovery' claims by the Consumer Credit statistics yesterday. U.S. consumer credit fell by $12 billion in August, after a $19 billion drop (revised downward) in July. This represents an annual decline of 5.9% and 9.1% respectively. Approximately three-quarters of the drop was accounted for by lower revolving debt (credit cards). So U.S. consumers have a lot less credit than they used to. At the same time, less consumers are working, the average weekly hours worked reached a record low in the September Employment Report and the savings rate is up. Nevertheless, I am fairly sure that when the third quarter GDP comes out, consumer spending will have risen during the quarter ... even though based on the previous information, this is impossible. The mainstream media will not question this statistical inconsistency at all. The market however might, by continuing to dump U.S. dollars.

The reserve currency status of the dollar has saved the U.S from decades of financial profligacy so far. It won't last forever. Small countries just collapse when they do what the U.S. is doing. Latvia is the latest example (Iceland was the first). An attempt by the government to fund its debt there earlier this week was the ultimate example of a failed bond auction. There were no bidders! Too bad they can't just print the money and buy their bonds the way the U.S. does.

NEXT: Fed Hits Dollar Panic Button

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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