Match Point for the US Dollar
Essay Posted November 13, 2007 by James E. Nelson
The US dollar’s had a tough go of it the last few weeks. Americans and others who hold a lot of dollars (the Chinese government, for instance) have seen a lot of their wealth evaporate over a very brief period of time. Of course the dollar’s tumble isn’t over yet. A nation can’t have as much debt as we do and not eventually have to pay the piper.
But I’m not writing this with a sense of gloom. Although one can never hope to predict the future, the price action of the dollar over the last month seems quite positive . . .
. . . given the alternative. Let’s go back nearly a month to Monday, Oct 22 and ponder what didn’t happen, and maybe you’ll agree.
Every now and then markets reach critical moments where a confluence of events points to the possibility of great promise or disaster. Think of it in terms of tennis.
When I was a kid I remember watching a tennis match on television. I don’t know how old I was, but I know that I didn’t know the rules of tennis. In spite of not understanding what as going on, I became engrossed in the excitement of the match. Finally we reached match point (according to the announcer). He made a big deal about how the whole match had come down to this single volley. In great anticipation I watched the final serve, the return volley, etc., until the ball was finally out of play.
And then the match went on for another hour.
At the time I was completely baffled by this turn of events. Later on, when I began to play tennis myself, I understood that if player B had lost that particular volley, the match would have been over, but in fact he won it, and went on to win the game and set, forcing the tennis match into a final, deciding set, which he subsequently lost. He was playing one of the greats of that era and I suppose his fate was sealed, but by winning that particular volley, he put off the inevitable for another hour.
According to a number of analysts and traders, Oct. 22 was match point for the US dollar. It was the confluence of long term factors (often called the fundamentals), short term factors, and technical indicators that had seemingly everyone in the industry all a-twitter.
Long term, the Bush administration, with the approval of congress, has spent more money than any other administration in history (and we have a year left). The government has been printing money at a rate that is truly breathtaking. Deficits have ballooned in a way that was truly unimaginable a decade ago. And last, but certainly not least, The housing market has been taking it on the chin, which has managed to drag down the American economy as a whole.
There is a debate about just how much politicians are responsible for the financial situation in the U.S. It is no doubt true that they get more credit and more blame for the economy than they actually deserve, but given the ballooning money supply and deficits, the current administration—which has been willing to spend vast sums of money without raising taxes to pay for the expenditures—is without question partially responsible for the current state of affairs.
There was also a short term setup that made Oct. 22 a “match point” sort of day. At the end of the week prior, the U.S. dollar broke below historic resistance. Currencies (and other financial instruments) tend to bounce off of major points of resistance and then change directions. But the dollar didn’t bounce, it broke right through the resistance line. The question was whether it was just a little spike down before bouncing higher, or whether resistance had truly been broken. (Subsequent price action affirms that resistance had truly been broken.) Since the dollar has never been as low as it is now, there are no more lines of resistance below this spot. The worry was that the dollar’s decline could completely spiral out of control (ie, “crash”) beginning the week of Oct. 22 if resistance had been violated.
A second factor making Oct. 22 an important day was that several countries (China, Japan, Arab countries, etc.) announced in the days prior that they have been dumping U.S. dollars and moving their assets into other currencies. The opinion that the dollar has historically been the “currency of last resort” in times of trouble seems to be changing. Increasingly, when things get bad, assets are moved into the euro rather than the U.S. dollar.
Let’s put this into historic context in order to understand why this could spell disaster: For decades (during the era of the British Empire) the British Pound was the currency of last resort. After World War II the U.S. dollar took over the mantle of the world’s currency from the Pound. The fact that a currency is the “reserve currency” (the British Pound, then the U.S. Dollar, and possibly now the Euro) gives it a significantly higher value. After the Pound lost that designation, it lost 80% of it’s value. These announcements from foreign governments are viewed worldwide as a possible death knell for the U.S. dollar.
Finally, there was the G7 (“Group of Seven Industrialized Countries” that form the biggest economies in the world) meeting over the same weekend. Speculation was rampant (among both dollar bears and bulls) whether the G7 would move to support the dollar or ignore the problem. It was the opinion of currency specialists that if the G7 didn’t do something, the dollar could plummet.
The only real word of moderation in the days prior to Oct. 22 came from International Monetary Fund Chairman Horst Koehler, who observed that the dollar’s decline had been orderly for the last few months. He also observed that in terms of fundamentals, the U.S. dollar was still overvalued, and he expected that the decline would continue, not in the form of a crash, but in an orderly manner in the months to come.
To paraphrase an old saw, if this is what your friends are saying about your currency, who needs enemies? So this was the situation on Friday, Oct. 19. The potential for disaster was starring us in the face, and those in the know were running for cover.
Jim Rogers, for instance: Rogers first became famous for co-managing the Quantum Fund with George Soros. In its heyday, the Quantum Fund made obscene amounts of money and in one of the most audacious moves in history, bet against the British Pound (in a trade that could have lost the fund billions) and broke the back of the currency, forcing the British government to devalue the currency.
Rogers was speaking at a conference in Amsterdam sponsored by the Dutch Bank ABN Amro at the same time the G7 and IMF were meeting elsewhere around the globe. Everyone at that meeting was jittery about Monday. Rogers was asked about the precipice the dollar was at. He responded, “I'm in the process of—I hope in the next few months—getting all of my assets out of U.S. dollars,” said Rogers, 65, who correctly predicted the commodities rally in 1999. “I'm that pessimistic about what's happening in the U.S.” (From Bloomberg Media.)
Then there is Brazilian Finance Minister, Guido Mantega. His appointment to that post back in early 2006 was greeted with a great deal of suspicion. At the time the London based Financial Times (as well as other prognosticators) predicted disaster for Brazil and their currency, the Real, because Mantega was considered a hard liner (that is, not friendly to free enterprise and biased toward excessive government control and spending). It seems their fears were unfounded. The international opinion is that Mantega has done an outstanding job and international investment is currently pouring into Brazil.
Over the same weekend as the G7 summit and the ABN Amro meeting (that is, just prior to Oct. 22), Mantega presented a paper at the IMF meeting. When he met with reporters after the session he was asked about the success of Brazil and the demise of the U.S. dollar (two separate questions). Responding to both questions at once, he said, “Allow me to point out the irony of this situation. Countries that were references of good governance, of standards and codes for the financial systems” were now “the same countries where financial problems were threatening to wreck global prosperity.”
It is plain that he is referring to American fiscal irresponsibility and the resulting decline (demise?) of the U.S. dollar.
All of this created a truly jittery weekend back on Oct. 20-21. Was Monday going to be a blood bath? The usual suspects were predicting apocalypse for the dollar and America as we know it.
Match point, and the outcome was inevitable. We were going the way of Zimbabwe and Argentina. The end of October would bring a currency crash of historic proportions and we would enter into a period of hyper-inflation and probably other horrible things that hyper-inflation brought in Argentina and Zimbabwe, like martial law, or some such thing.
But it didn’t happen. In fact on Monday Oct. 22, even though no one came to the dollar’s rescue, the dollar managed a bit of a rally before resuming it’s downtrend.
It seems Horst Koehler (above mentioned chairman of the IMF) was right, in spite of the dollar’s dire situation, it’s decline will continue to be orderly.
And in the larger scheme of things, this seems to be overwhelmingly good news. Oh, sure, things will be more than a bit unpleasant for the next decade or two. We Americans are going to have one heck of an economic hangover from the ongoing excesses since World War II. We’re going to discover that all that wealth we think we have is a mirage.
But in spite of the inevitable coming “correction,” it seems we Americans are made of solid stuff. We didn’t panic. We didn’t queue up in front of the bank like some of the Brits did the week before. We didn’t burn cars and turn over busses. We didn’t riot in the streets.
And because we didn’t do anything hysterical in the face of our decades of foolishness, the world’s money changers gave us a break.
Whether it’s Hillary or Obama or Rudy or even Ron Paul (I have to use both his names because nobody’s heard of him) in 2008, the new president will be great news simply because we managed to avoid that fateful “match point” when other countries in similar straights declared martial law.
It’s probably the best thing that never happened to us to come along in months!
Copyright © 2007 James E. Nelson (Just Another Jim). All Rights Reserved.
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