Artificial U.S. Dollar Rally Is Coming to an End

Currency markets are hard to understand for many investors, and even I have to admit that I don’t understand certain price movements, especially short-term price moves. In my view, investors often make the mistake of not being able to distinguish between a trade and a strategic investment decision. A trade is done in anticipation of short-term price development, whereas a strategic investment is made on the basis of a longer-term fundamental investment rationale. In foreign exchange markets the price dynamics are even more complex. I learned this when I was working as a currency strategist for one of the biggest U.S. companies.

At Alpine Atlantic, we help people from all over the world to get proper international investment diversification. For North American clients, this means helping them manage their U.S. Dollar related investment exposure. For them, we typically sell U.S. Dollars as a first step towards international diversification. We have become more bearish on the U.S. Dollar in recent weeks just when the currency showed renewed strength. In our view the temporary U.S. Dollar recovery was driven by the global deleveraging process. We predicted this artificial U.S. Dollar rally would come to an end soon and the market would focus on the structural weakness of the currency.

In these last days of 2008, we are becoming witnesses to a renewed U.S. Dollar weakness. Just since the beginning of the month, the currency has lost 15% versus the Euro and the Swiss Franc, with the selling pressure accelerating in the last couple of days, a movement that is finally reflecting key fundamentals. We expect further selling pressure in coming days and weeks and can only see very few factors that indicate an end to this trend.

I am often surprised to hear arguments from investors when they talk about currencies. Today’s foreign exchange market is an extremely big and liquid market, and is in fact a system where the relative value of countries and their economies is measured. How many times have I heard arguments and statements from confused investors who try to explain and predict currency movements with things that just don’t make sense?

People talk about macroeconomics, money printing, gold standards and other concepts without really understanding their meaning in a broader context. The value of a currency is never driven by a single factor but by a number of drivers whose impacts change, sometimes very quickly, and a currency is therefore a relative measure of the value of an economy. Paper money, or Fiat money as it is called in economics, is a global measure of value of individual economies, and this system can’t be manipulated as long as currencies are allowed to be freely traded. And we certainly don’t need another gold standard anymore, because it would not properly reflect the true value of an economy.

Therefore the foreign exchange market is comparing the relative value of various countries and their currency, much like stock prices in equity markets. And, the share price of the United States Inc. is going down at the moment. The temporary recovery of the U.S. Dollar in recent months was driven by the global deleveraging process, but now this is reversing and the market is focusing on fundamental values again.

Don’t get me wrong, I am not saying that things are so much better over here in Europe and in other parts of the world, actually I think some things are even worse here in Europe. It is still true that most economies over here in Europe are not as flexible as the U.S. economy, but I believe that in relative terms, Europe has been improving and closing the gap. But let’s face it, the U.S. and Europe will become less powerful and important in the next decade as other regions such as Asia emerge, and that’s why I believe that the current U.S. Dollar weakness is a serious structural weakness and in fact the beginning of a real paradigm shift.

Don’t be surprised to see more U.S. Dollar weakness in coming weeks and we advise investors to diversify their currency holdings and diversify investments globally.

Comments

[daniel3582:]

Great article, Daniel... I have been considering a play with UDN or TBT. This is one of many articles that I've consulted regarding this decision.

2008 Dec 19 07:16 AM

[kotika98:]

beyond the blah blah about the long-term vs short term, what do you think the underlying fundamental driver is here? Name one or at most two.

imo, the main driving factor in the dollar recovery was that the fed qwas done cutting and ECB just beginning. And if you wanna talk about real economy, instead of interest rates it is the same - US will be coming out of recession in 6 months, where europe is just sliding into a another multiyear malaise. And if political divisions surface, as i think they will, people might look at ECB as an organ without the backing of a national body with political authority. So far, for the first 10 years it hasnt been a problem, but as we are painfully reminded this year, any structural weakness eventually playes its role.

2008 Dec 19 11:00 AM

[win:]

kotika,
The author is not comparing the Dollar to the Euro; in fact, if you read the article to the end, he admits the possibility that Europe will be worse of than the United States. He is advocating for Asian currencies, in the belief that global economic power is going to shift. That, in my opinion, is undeniable; even if the U.S. remains an economic superpower, as I believe it may (and hope it does), Asia, in relative terms, is undervalued compared to future potential. And some of their currencies (and I don't mean the Japanese Yen) are severely undervalued.

2008 Dec 19 11:15 AM

[investman:]

So how do you respond to Jack Crooks who says the dollar goes up in a defaltionary economy and we are in the midst of a defaltionary economy?

2008 Dec 19 11:47 AM

[tiredinvestor:]

US has the benefit of a "central command" but monetary policies for California are not necessarily good for Iowa, as it happens in Europe. Euro is based on the german mark and it is very important to understand the importance of a strong currency for the germans who had hiperinflation in 20's.

I am not an economist but I do understand that the move of the FED is to devaluate the dollar "as much as necessary". I think that this may help the economy and prevent too much pain to workers in exchange of being all a bit (or a lot) poorer. Will the dollar be stronger when the economy recovers if it has been based precisely in a dollar devaluation? I don't thinks so.

2008 Dec 19 12:33 PM

[Socialism c...:]

"Paper money, or Fiat money as it is called in economics, is a global measure of value of individual economies, and this system can’t be manipulated as long as currencies are allowed to be freely traded."

Wow...someone is really on the kool-aid!!

2008 Dec 19 01:00 PM

[OldLimey:]

kotika98: "US will be coming out of recession in 6 months, where europe is just sliding into a another multiyear malaise."

Unless you believe that the US consumer is set to lever up even more and drive another consumption binge, just what is it that you expect to drive this miracle? Bail outs and infrastructure spending? It will take years to restructure Detroit and rebuild the country's infrastructure. And even if you're correct, the US will also be emerging from recession with an utterly trashed financial system, historic budget deficits, heaven knows how much money supply growth, and an unrepayable debt burden which the rest of the world is now fully focussed upon. Europe's certainly in dire shape, but painting US recovery as a first-in, first-out V-shaped ascent into the sunlit uplands of prosperity while the rest of us linger on in the swamps of monetary delusion is infantile.

2008 Dec 19 01:11 PM

[DRumsfeld:]

Nobody knows what is happening and that is why we are having these wild forex swings. My bet is that the Dollar will severely decline in 2009 once the true crises in the USA is realised and people realise that Obama cannot fix it. Obama's plan is to spend spend spend and this means borrow borrow borrow. It is unrealsistic that the Bond market can survive the coming blitz of money demand. Expect monetisation and a falling Dollar.

The Euro will be under pressure, but the major economies have high savings rates and do not have to print money to afford priming the economies. A big and substantial difference. The US has negative savings (Govt and private), massive debt and a severe and worsening economy. The US also needs to borrow over $2.5bn a day right now just to stay afloat. Seems unrealsistic for this continue with interest rates at zero.

2008 Dec 19 01:15 PM

[Fabien Hug:]

The author says the $ is going to drop but he barely says why. De leveraging is maybe THE reason why the $ rose but why would the $ drop or any other currency rise? Frankly, if we talk structural, I don't see why the $ should be dropping. The US worker can take much bigger its than the European one and as for government spending, everybody is waiting for the US money. Nobody is expecting a German program that will allow German citizens (or French or whomever) to buy Imacs and Chevy Corvettes. The only currencies I would watch are developed commodity currencies (A$ and CA$) if inflation comes which is not the case now. Furthermore, if you compare relative value,except Japan and Switzerland, I don't find any superior relative value in any other countries. That's why I don't feel negative on the US$.

2008 Dec 19 02:38 PM

[Lin:]

Re
The Plunge protection Team aka Hank has stated " we stand ready to intervene in the currency market if needed ". This market WILL be manipulated . We have no markets any more , merely " interventions" .

2008 Dec 19 07:47 PM

[S M J:]

I agree with the author to the extent that while US$ is probably in for another round of decline and given the upcoming lower unemployment figures that economists are predicting for Europe, it is likely that Euro will also follow the suit later on, perhaps by mid 2009, the best bet is the Asian currencies (rightly argued by one commentator except Yen). Warren Buffet is no stupid when he moved most of his stock holdings to South Korea by pulling out of the US and China.

2008 Dec 19 11:38 PM

[Moon Kil Woong:]

When you talk about currency weakness you should specify relative to what. If you look at Europe it is hard to say the US has more structural weakness. If you are saying relative to gold then are you suggesting the dollar is structurally weaker than a metal that is largely overproduced to sit in valuts since only strange rappers would wear a 5 pound gold chunk on their chest.

If you are saying relative to the Yen, I would buy that but the train already looks like it has taken off. Japan is now also going to bat with the funny money machine.

However, if you are saying the Federal government has ceeded all money making authority to the Fed and they are balooning their assets out of control with no oversight, then you are talking. Essentially the Fed has loaned and guaranteed trillions more than TARP without anyone saying so much as boo. I find that very very strange and silly.

Disquieting to say the least. Where is the accountability or the democracy in that. Simply said, there isn't any. At this rate the Fed will inflate their balance sheet to own 20-30% of the US economy. At 2.3 Trillion, up from $800 billion, they are already over 10% there.

2008 Dec 20 08:39 AM

[hedgeman:]

We are witnessing a hystorical experiment. If it works Ben & co. will go in the history books as great thinkers, if it backfires it will be blamed on the "crisis" of whatever sort. There is no risk for policy makers and that's what will bite at the end.

It is easy to see a hidden subsidy to banks when FED purchases the Tbonds and Tnotes and banks realise great profits and hence improve their capital base. FED will buy the top (quantitative easing) and there is a direct cost of abt. 150 billion which will be banks "improved capital". TARP is a smokescreen, the bigger transfers take place between the FED and its owners.

After FED buys long end from the banks then it will be time for some 10-30 steepeners as a strategic longer term view based on simple fundamental reasoning.

2008 Dec 20 10:18 AM

[Non:]

Daniel, you are totally wrong when you say fiat currency standards reflect the true strength of an economy and the gold standard don't do this. The fallacy of your argument is the same as the fault with market fundamentalism. Things just get MORE and MORE out of whack, there is no self correction mechanism before things are really out of hand and crash, that's why the currency tells very little about the strength of an economy, rather it's more like a voting machine measuring how popular it is, like the pseudo strength of the US economy in 2000 or in 1985. When you have a gold standard, you avoid the idiots in the market place through the function of reflexivity get things get totally out of whack through their faulty perception's. The gold standard helps to avoid all the people such as yourself, driving currencies in the sense that the market is always more or less wrong.

2008 Dec 20 06:59 PM

[James Brumley:]

I appreciate the article, and understand the rationale. However, there's no such thing as an artificial rally....things rally for a reason. It may not be the best reason (or even a good reason), but there's nothing artificial about it..... the dollar rallied because FX traders saw more value in dollars than in other currencies - at that time. I can't say I blame them. If there weren't artificial rallies, the market would return about 2.5% per year, on average. There's no net 'return' on forex markets, but the idea still applies. What is and what 'should be' can be vastly different things.

2008 Dec 21 12:39 AM

[Sunnsea:]

The dollar rallied because hedge funds had to redeem their foreign investments and convert them into dollars to meet margin calls. That is coming to and end. The one thing Europe has going for it is that its products are in demand, they are exporters in a way that the US is not. They will earn back those strengthening Asian currencies because of their a) consumer priducts, which are superior to American and have cachet in Asia and b) their machine tool products which allow the Asian economies to turn out the cheaper goods that have no cachet. Germany, Italy and France alll turn out designer labels from clothes and shoes to cars that are widely sold in Asia and Germany and Italy sell machine tools to the same countries except Japan. Americans are totally clueless as to what it takes to compete in this market as they have been so interested in consuming themselves they have forgotten how to make high quality products that do have cachet. Asians don't want "Made in China" products. They want "Made in Italy."

2008 Dec 21 08:21 AM

[nevket240:]

If you have a "Reserve Currency" that can be printed at will you are NOT measuring anything.
If you have multiple Reserve bank interventions in the "market" you are NOT trading anything freely.
regards. (its just another "funnymoney racket")


On Dec 19 01:00 PM Socialism cannot compete! wrote:

> "Paper money, or Fiat money as it is called in economics, is a global
> measure of value of individual economies, and this system can’t be
> manipulated as long as currencies are allowed to be freely traded."
>
>
> Wow...someone is really on the kool-aid!!

2008 Dec 21 09:34 PM