The dollar is widely regarded these days as a "one-eyed king in the land of the blind." But is the "King Dollar" thesis really all it's cracked up to be?
Last week, when I wrote about building a short position in the greenback, a number of you wrote in to remind me of the 'King Dollar' thesis.
What is the King Dollar thesis? Basically it goes like this:
In the land of the blind, the one-eyed man is king. Right now the global economy is in such poor shape, the USA actually looks better off than many other countries (the best of a bad lot). And since all currency trades are relative, i.e. a currency's value is always measured in relation to other currencies, the dollar will hold up in 2009.
I can see the logic of this view. But it feels a bit too clever (and widespread) for me.
I'm still admittedly bothered, too, by how popular the short treasuries trade is. It almost feels like conventional wisdom at this point. In the past few days, I've come across multiple outlets singing the praises of TBT, the ProShares UltraShort Treasury ETF. (More on treasuries tomorrow.)
I'm not trying to be a smart aleck here... the situation just smells funny. Everyone "knows" treasuries are headed for the tank... and plenty of people also "know" that the U.S. dollar is still king and won't be going down for a while.
What's wrong with this picture?
Maybe nothing. A calling card of trading skill is the ability to change one's mind – and as a trader who eats his own cooking, if the conventional view bears out I'll happily do that.
But in the meantime, here's some food for thought.
Nobody Prints Like Uncle Sam
The Financial Times notes that the big developed economies are slated to issue $3 trillion worth of new debt in 2009. Two-thirds of that, or a whopping $2 trillion, will come from the United States alone.
Nobody, but nobody, prints like Uncle Sam. The other guys are pikers compared to us.
For instance, the ING Group estimates dollar-denominated emerging market debt sales will hit $65 billion in 2009... a mere drop in the bucket.
Heck, in comparison to President-elect Obama's rock-em sock-em stimulus plan – which many hand-wringing Keynesians are already calling "too small" – $65 billion is practically a rounding error.
China's Belly Is Full (and Beijing Is Feeling Sick)
"China owns $653 billion of Treasuries," notes Bloomberg columnist William Pesek, "and indications are that it's losing its appetite for U.S. debt. Expect Asia's second-biggest economy to cut the share of dollars in its $1.9 trillion of reserves, and perhaps sharply."
"Economists at Deutsche Bank AG in Frankfurt," Pesek goes on to note, "estimate China will trim the share of dollars to about 45 percent this year from more than 70 percent in 2003."
With the U.S. on track to borrow a cool $2 trillion in 2009 (on top of all it already owes), a China disgorgement is not good news. The greenback could be in trouble as soon as Beijing markedly slows the pace of its buying... let alone starts dumping.
Then, too, there is the question whether China could afford to keep buying USTs (and thus U.S. dollars) even if it wanted to. The dragon has its own stimulus plan to enact – with outlays running well over half a trillion – and foreign currency inflows ain't what they used to be.
Protectionist Forces Favor a Weak Currency
As I've said repeatedly in these pages, the Fed needs to keep interest rates low, which in turn means keeping bond prices high. (Bond prices and interest rates move opposite one another.)
The Fed has openly stated (or perhaps threatened) its willingness to "defend" USTs if need be. For the Fed to step up and "defend" USTs in the face of a China-selling onslaught, it would have to print new dollars with which to buy China's dumped bonds.
I suspect this is just what the Fed would do, especially if the economic outlook stays grim. And you know what? A dollar-deluge turn of events would be fine and dandy with America's trade unions and other protectionist forces. Why? Because those guys are all very much in favor of a weaker buck.
A weak dollar helps America's exporters (by making the stuff America sells less expensive). A weak dollar also makes imports less attractive, pushing consumers towards local-made goods.
Remember the big protectionist flap from Senator Chuck Schumer a couple years ago? That was about China's currency being too weak relative to the dollar. Schumer was throwing red meat to his base in trying to cajole China's currency up.
That same protectionist base would be happy to see the dollar weaken now. On the flip side, they would be righteously pissed to see it strengthen – and with Dems in power they very much have the floor.
Countries That Save Don't Like to Inflate
For another conundrum, check out the Japanese yen.
Does that look like the currency of a country fighting off serious recession to you?
Japan's interest rate has flirted with zero for ages. The Japanese government swears it is serious about solving the deflation problem. It has been saying the same thing for years... and yet the yen rises. A stronger yen is brutal for Japan's exports... and yet the yen rises.
This is a head-scratcher for most Americans. Why don't those Japanese bankers just get in there and inflate, no-holds-barred American style? Why don't they just blow the doors off?
Japan has done a fair bit in the stimulus department, to be sure... but you just get the sense they haven't gone "all in." Certainly not like the Fed and Treasury have gone all in. Why?
Maybe because Japan is a nation of savers (as are many other Asian countries, and many emerging market countries in general).
The mindset is different for high-saving nations. While inflation is a godsend for heavily indebted folks, savers hate it. To savers, inflation is a punishment for being prudent (and a reward for being reckless).
Because of this mindset, savers tend to be more touchy about turning their currency into confetti, even when times are tough.
We in the reckless United States (speaking collectively here) don't have that inhibition.
Markets Like to Fool People
Something else: markets can be tricky. (Surprise! But seriously...)
Last week the Bank of England cut rates to the lowest levels since 1694. (No, that's not a typo. U.K. rates are now the lowest they've been since the BOE's doors first opened on Threadneedle Street.)
When a central bank slashes interest rates, it generally makes a currency weaker, not stronger. So what did sterling (a common name for the British pound) do on this historic rate-cutting news?
It went up.
"Sterling makes a strong comeback," the FT noted, "posting a record weekly gain against the euro and putting in its strongest performance against the dollar since 1985."
The thing is, markets like to fool people. When a belief or an expectation is widely known, the market tends to "price it in" beforehand. Then the news comes out, and the market does something surprising.
Getting back to the U.S. dollar, I have to wonder how much "recency bias" is coming into play – a psychological phenomenon in which people imprint on a recent set of circumstances.
Many were quite surprised to see the greenback rise sharply in 2008, as dollar-based investors yanked their capital from emerging markets.
So now, with that imprint fresh in their minds, the budding theme is "Yep, the dollar will be strong as long as times are hard... the U.S. is better off than all those busted emerging market countries... the buck won't break for a while..."
Color me skeptical.
It's a Trader's World After All
Remember this too: the reality of being a trader is that all opinions are flexible.
I view opinions as useful starting points... a way to winnow down a huge universe of opportunities to a handful of ideas worth acting on. (As Bruce Kovner once said in Market Wizards – paraphrasing here – "You make your first best judgment, you make your second best judgment, and then you double your money.")
As mentioned earlier, I'm a trader (and investor) who eats his own cooking. I'm out there surfing the waves just like you. (I may not buy and sell the exact same things as you, but there are many ways to skin a trend.)
My active participation in markets makes me a ruthless opportunist. Every single day my trading P&L reminds me that it's not about being right... it's about making money. I'll continue sharing my thoughts in that spirit.