Dollar On The Rise, But Risks Lie Ahead

by: Leonid Kanopka

With unemployment stuck at about 9% for several months and consumer spending at a standstill (0.7% increase in July and 0.2% increase in August), the growth of the U.S. has come to a complete halt. Despite these troubling economic factors and quantitative easing, the dollar has managed to make substantial gains against other major currencies. For several weeks now, 60% of those who trade the euro against the dollar have been buying dollars, and 80% of those who trade the U.S. dollar against the yen have favored the dollar.


Reasons for the U.S. dollar's strength:

  • Individuals exit all asset classes, selling in mass, which creates a huge demand for dollars.
  • Banks are not lending, which helps tighten the money supply at the consumer level.
  • The reduction of USD denominated liability by foreign banks creates a demand for the USD.
  • In uncertain times, investors prefer cash over risky financial assets.
  • The rest of the world is seen as being weaker than the U.S., especially the euro-zone.

Given the concerns with the U.S. economy and the recent downgrade, the fact that investors have been loading up on U.S. denominated securities may seem counterintuitive. However, history has taught us that in times of uncertainty, the dollar is assumed as a safe haven. Given the flock of problems domestically, it is clear that investors continue to feel that the U.S. is better positioned to face an economic storm than the eurozone-- or any other economy at that. The dollar has gained roughly 6% against the Euro from July-September, and the Greek debt crisis could have a further negative effect on the Euro.

Of course we cannot look at past performance alone, and expect the USD to continue it ascend. I have found several pitfalls that could potentially point to a drop in the value of the dollar.

Reasons for the U.S. dollar's potential downward surge:

  • If the European Union, European Central Bank, and the International Monetary Fund manage to prevent a Greek default, it will likely reduce demand for the USD.
  • The Fed revised its outlook for U.S. growth downwards, which could force the Fed to implement a third round of quantitative easing.
  • Operation Twist seems to already be failing.
  • We are headed towards a double dip recession.

The Fed's first two efforts of quantitative easing were controversial. The results have been mixed at best, some believe it helped while others feel it did more harm than good. However, One common theme QE1&2 share is that the increase of "cheap" money not only adds to the overall money supply, thereby devaluing the currency, but it also increases fears of inflation. Because of the controversy of the first and second round of quantitative easing, the Fed announced Operation Twist. Operation twist is the plan to sell short-term securities in the Fed's inventory and use the proceeds to purchase longer-term bonds. This plan seems to push the crisis down the road instead of dealing with the issue, or as the president says "kicking the can down the road." However, the Fed predicts that Operation Twist will lead to lower yields on long bonds and should discourage investors from simply buying and holding bonds, which in turn will free up more cash, thus finding its way back into the financial system. Theoretically, this would help increase liquidity without physically adding to the money supply.

The sharp rise in Gold and other precious metals is a heavy indicator that the dollar could be on the brink of another collapse. This explains why liquidity has rushed into the commodity markets as the only true protection against the accelerating currency crisis. Gold has increased substantially since the crisis began, and after a selloff at its high of $1,900, has began its ascent again.


These coming months could tell a lot about where we are headed, and what to expect for the next several years. It is no question that we are on the brink of another recession, and the short term fixes that helped us out of the "great recession" of 2008-2009 might have put us into an even deeper one. Personal income is falling while food and gas are rising. It seems that we have come to the conclusion that inflation does not seem to be a major factor, but I feel quite the contrary. With a current national deficit of almost 15 TRILLION it is hard to imagine how our currency or economy will sustain this type of reckless spending.

The only thing I can compare the crisis to is a broken car (our economy being the car). The dollar has rebounded recently with the economy (like a temporary fix to a leak on a car), but like the broken car, our economy was fixed temporarily and incorrectly. Fixing one problem just led to a trough of others that has signaled fears of another depression. Looks to me that hyperinflation and a crash of the dollar are looming. My suggestion; buy precious metals and commodity mining stocks such as the following: Stillwater Mining Company (NYSE:SWC), North American Palladium (NYSEMKT:PAL), Patriot Coal Corporation (PCX), Silver Standard Resources (NASDAQ:SSRI), Coeur d'Alene Mines Corporation (NYSE:CDE), James River Coal Company (JRCC), Pan American Silver (NASDAQ:PAAS), etc, as they have proven to be a safe haven.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.