End of Bubble: US Dollar Soon Again Attractive

Looking past the detail and the noise, we wager that a world-wide bubble is in its last stages. To this point, a massive credit inflation has infected virtually every investment class … to the farthest corners on earth. This, unsurprisingly, is not readily identified by most analysts. Once inflationary forces have percolated for a long period of time, it is no longer possible to separate cause from effect. The original inflationary impetus to the boom has been long lost into a myriad of channels which loop back upon themselves. After a while, the results of the original impetus become the base upon which even more excesses are validated.

How can we deduce that the global bubble is in its last stages? Frankly, we can’t time this precisely, however, we can be reasonably sure that a number of bells have rung. Firstly, the great global “non-bank” credit machine has lost its engine. It is dead in the water as of the sudden “credit revulsion” of this past summer. It can no longer navigate its own destiny. It may sputter and burp for a while, but the clock is ticking. Only the momentum of “bullishness” and “never say die” optimism has kept the financial ship moving forward … for now.

Next, the world’s largest economy is headed into shallow waters. It is unrealistic to believe that the rest-of-world economy can decouple from the US… at least not quickly. Much evidence argues that this is improbable. If anything, every country is over-exposed to its own variant — or counterpart — to the global bubble as never before. For example, China today is more export-oriented than previously, as less of its economic output is directed to domestic consumption. Conversely, the overextended consumer, in countries such as the US (also Ireland and Spain, for example) has become even more dependent upon debt as household savings have collapsed.

What’s the solution? According to central banks, the sure short-term sinecure to today’s imbalances and untenable valuations is ”more” — namely, more excesses, more debt for the indebted and more surpluses for the surplus countries. The road of least resistance to this outcome is lower interest rates in the US, and a continuing tight-link to the US dollar by China and the major oil exporters. But, this can only continue for a short time at best. It won’t be long until Europe spoils the party as its economy comes under downward pressure. They will not be as beholden to China as America (they don’t need China’s surplus!) and they will not appreciate the “beggar thy neighbor” policies of a profligate US whose currency is in a death dive.

Today we see evidence of panicked investment capital. Some of it is trapped inside the deflating world of structured finance. Other parts are trying to escape depreciating currencies and money. At present, a reactive reverberation has been to move into areas that were “hot” already … emerging markets, China, commodities … etc. (See "Figure #4" below). That is all fine if the world can indeed decouple from an economic downturn in America. But, that has long odds.

Our long-running forecast that the US dollar would fall to at least 1.45 to the euro is finally reality. That brings no joy. But, will it fall further? Possibly. A final capitulation phase could surprise as to how deep it may fall. (In fact, anything is possible in financial markets, witness the inanity of the Canadian dollar hitting 1.10 as its guardian, the Bank of Canada, remains toothless.)

Yet, we are inclined to look for the US dollar bottom. Likely it is near. The rest of the world [ROW] looking upon America is still mesmerized by the American Way … reputedly the land of the brave and the free … the Super Slurpee … this vast dynamo of a beautiful country. Deep down, most foreign investors continue to believe that America is a safe bet for the long-term. Is the US going through a bit of slow-down … a bit of currency trashing? Yes, of course. It is deserved. But economic adjustments will now occur, feeding through to other world economies. Gradually, the trade (non-energy) deficit will shrink. Once foreign equity markets begin declining significantly in anticipation of a slowing global economy and the USD has put in a bottom, it is possible that a torrent of foreign-invested portfolio capital will return to the US. Some estimates put the value of this foreign investment at over $1.5 trillion (and rising as the US dollar falls.)

From our perch in Canada, the next few months likely present the lowest risk buying opportunity of US dollars in at least a century. US "large-cap" companies with significant overseas operations are also attractive on a relative global basis as these are best able to weather an economic slowdown. America will survive for a few years longer.