The role of the U.S. Dollar as the worlds reserve currency kicked into gear this past week which accelerated the up trend of the US Dollar towards its initial forecast target of USD 90 as per the analysis of mid August 08 which was made against the overwhelming consensuses at the time that basically viewed an imminent collapse of n the US Dollar. Which despite the exceptionally strong rally to date that consensus more or less remains in tact today, where still the vast majority of views remain that the Dollar's rally as temporary in advance of a much greater and near imminent collapse.
Even though I do understand the arguments put forward for a dollar collapse i.e. of the huge debt mountain, unfunded liabilities in the tens of trillions, rampant money printing by the central bank, and the huge federal budget deficit. However there exists the failure to recognise the fact that the U.S. Dollar has come out of a 7 year Bear Market i.e. it is NOT an over-leveradged market looking to unwind, on the contrary deleveraging of the credit bubble looks set to continue to drive the U.S. Dollar higher not only for the duration of the credit freeze which appears to be starting to thaw, but also for the duration of the global recession, as the rest of this article seeks to elaborate upon.
U.S. Dollar Worlds Reserve Currency
The fact of the matter is that unlike virtually all other countries, the United States CAN more or less get away with printing as much dollars as it likes in an attempt to fix the credit markets and alleviate the impact of the recession. Any other country will take a hit in terms of a plunging currency which is in proportion to the size of the economy, this has been witnessed by the collapse of the Icelandic Krona, and as we saw this week the British Pound crashed by some 10% on bad economic data.
The only real problem on the horizon for the U.S. is if another currency became the worlds reserve currency. Clearly there exists one such currency that many eye as a potential contender which is the Euro. However, to achieve this the European Union needs to be significantly more powerful in economic turns than the United States, as well as exhibit policies that supports a reserve currency role.
The Financial Crisis could be such an event, however as I mention above that Europe actually needs to implement policies that foster the idea of the Euro as the worlds reserve currency, which has so far not done so due to the nature of the European Union.
There are suggestions that the emerging giants such as China could take over aspects of a reserve currency given their huge reserves, however the problem staring us in the face here is that China and all of the other countries hold their reserves in U.S. dollars. Still the weight of reserves does influence U.S. policy towards countries such as China which was evident in the bailout of Fannie and Freddie Mae which so as to give U.S. Treasury status to the Fannie and Freddie Bonds held by China.
Another critical determinant of the US Dollar as an reserve currency is the fact that crude oil is by and large priced dollars despite some nibbling at the edges of movement away i.e. Kuwait's and Russia's actions. However, if the dollar strengthens as we have seen this would tend to reinforce the petro-dollar.
Bankrupt Iceland Leads the Way to the U.S. Dollar Safe haven
The bankruptcy of Iceland has brought home to financial institutions the world over that they are at greatest risk from holdings in the currencies that are backed by the smallest economies. In that respect the larger the economy the safer the currency and in that respect the U.S. Dollar remains king as a function to the size of the U.S. Economy, and therefore the United States is perceived to be the last man standing as the last that would be expected to experience economic collapse. Iceland was the first to go but won't be the last, many of the small countries will be driven towards bankruptcy with all of the consequences for depositors and into the arms of the IMF as my analysis of 2nd October warned
Therefore the credit crisis is engendering huge added demand for the U.S. Dollar that actually requires the U.S. Fed to print trillions more dollars in an attempt to satisfy the demand of panic buying of dollars in exchange for local currencies, which implies that the U.S. will use this advantage of having the worlds reserve currency by flooding the world with trillions more dollars in an effort to boost the US economy, which means in the immediate future this will have the effect of boosting the US Dollar even further despite the extra money printing as the world will see a greater relative strength in the reserve currencies economy relative to other economies and hence continuing relative Dollar strength.
Similarly the second largest economy in the world which is actually backed by stronger overall fundamentals also continues to benefit i.e. Japan, and thus will likely enable Japan also to go on a spending binge to inflate their economy with cheap Yens. Therefore this suggests that the two strongest economies of the developed world going forward will be that of the United States and Japan.
Meanwhile Europe has shown itself it be many years, and perhaps many decades away from being in a position to offer international depositors a viable alternative to either the Dollar or the Yen.
Global Recession Bullish for the U.S. Dollar
Whilst many analysts continue to correctly point out that the large emerging markets of China and India that look set to continue growing during 2009 and beyond albeit at a much reduce pace. But the talk that emerging growth will prevent a global recession fails to understand that in global economic growth terms the emerging giants are more than offset by economic contraction amongst the developed world and hence we are swiftly plunging towards a global recession due to the relative size of the developed world against the smaller emerging economies.
From what I can glean from the mainstream media, the psychological impact of this has not yet hit home, however clearly the market consciousness is aware of this and hence the deflationary trends being observed and the flight towards the worlds first and second reserve currencies i.e. the U.S. Dollar and the Yen, in fact the Japanese Yen is being fed by the stronger dynamics of the reversal of the carry trade.
Therefore this suggests that the impact of the global recession will lead to a prolonged rally in the U.S. Dollar for the duration of the recession, as eventually even the emerging powerhouses of India and China succumb to economic difficulties with signs already appearing in China of escalating company closures in many of its industrial heartlands as the West demands less Chinese goods. As emerging markets succumb to economic weakness the tendency will be to devalue their currencies against the US Dollar and other western countries so as to stimulate overseas consumer demand for exports.
Additionally in advance of the economic downturn, Dollar investments abroad are in the process of being repatriated back to the United States, and the same holds true for other Western countries that invested heavily in the emerging markets.
Gold Fails to Shine in its Moment of Glory
Those looking towards Gold to resume its role as the worlds reserve currency have received their answer. For the financial crisis was THE seminal moment for Gold to shine and take up the reserve currencies mantel, but it clearly FAILED to do so, this is telling me that much chatter of a return to the gold standard is not going to happen. Yes gold still functions as an inflation hedge of sorts and in times of financial or economic distress some will turn to gold due to memories of time past, however whatever happens in the future with regards the Dollar, one things for sure that central banks, governments, and financial institutions do not view gold as a viable alternative to a FIAT reserve currency. On a positive note Gold has outperformed most other commodities and asset classes in having fallen less in dollar percentage terms than what other markets have, so there is still a limited role for gold as a safe-haven, just not the safe haven that many gold investors had imagined or hoped for it to become. Still gold will benefit from the mega-trend as the investment strategy elaborates upon.
In my earlier analysis - Stocks Bear Market Long-term Investing Strategy , I suggested a strategy for long-term investing in the aftermath of the crash of 2008 and during the remaining bear market with the focus in the mega-trends of energy, agriculture and other commodities, if anything economic contraction will be eventually even more bullish for commodities in the long-run as investment is cut back due to deleveraging and recession. Whilst people's focus appears to be on Gold, investors may miss the collapse presented in other commodities such as Platinum which has crashed by over 60%, against Gold's drop of 30%.
The current trend of deflation confirms that asset and commodity prices will continue to be depressed over the next 6 to 12 months and hence feed the suggested accumulation strategy which has a 5 to 10 year return time frame on the premise that stock markets will bottom long before recovery in the economic data becomes apparent, as is the fact that the markets have already discounted deflation to a significant degree and at some point will start to discount the coming reflation and economic recovery by adjusting asset prices higher. The investing strategy analysis suggests a low for the major western stock indices between May and July 2009.
Analysis of March 2008 - DELEVERAGING- Gold and Commodities Teetering on the Brink of a Bear Market? suggesting deleveraging deflation to continue into early 2010, therefore implying that the stock market trend following the mid 2009 low will be subdued or more saucer shaped in formation.
Off course a full fledged economic depression would blow this strategy out of the water, however I do not see such an outcome despite much of the mainstream media looking towards the 1930's as a comparison, though closer analysis should show that recessions are always different then the ones before as policy makers take into account of what transpired in the past and hence the outcome tends to be for something that is different and perhaps unexpected than the conclusions arrived at early on during an new economic down-turn.
U.S. Dollar Bull Market Technical Analysis
The above is based on the big picture assumptions and now for down to earth Technical Analysis of the actual price action which is an update of the analysis of mid August 08 - "The US Dollar will target a move towards significant resistance at 80, following which the Dollar is expected to consolidate with the previous resistance levels turning into support levels i.e. Major support at 74.30 and 78, before the next leg up through resistance above 80 takes place towards a longer-term target for the dollar of 90."
