Keep An Eye On the Dollar

Europe is "rolling over". Old money is learning new tricks. The Euro is estimated to be over priced by 25%. Can an efficient market be over priced by 25%? Certainly! The smell of fear often leads to irrational behavior.

There are basically two types of money, "safe money" and "aggressive money". The problem the world markets have been dealing with is that "safe money" no longer seems to be "safe". "Safe money" is no longer a "sure thing". Recently the "sub prime slime" showed up in a GE money market fund. GE is offering the holders of this "safe money" account 96 cents on the dollar. "Safe money" is typically left lying around in money market accounts even while the owner knows he could be earning much higher returns.

High returns are not the point of safe money. Those who leave money in these accounts are concerned about the return of their money not the return on it. If you are rich enough, accepting the losses due to taxes and inflation on substantial sums is not seen as a big deal, losing principle month after month and year after year grows into a disaster.

Wealthy folk who have had safe money accounts in Europe and America have seen their American money fall in relative value by 35% or more. Those who had equal amounts in Europe and America made as much in Europe as they lost in America but losing is still no fun. Aggressive investors saw similar results but they moved quickly to correct the problem. Indeed, the most aggressive investors jumped to China to rack up substantial gains last year. One of the differences in safe money and aggressive money is that safe money is relatively slow. Another name for aggressive money is "hot money", because it moves quickly.

After five years of seeing the value of American safe money fall in value relative to safe money, in Europe the flow of safe money from America and to Europe has gradually increased. The sub prime mess served as a catalyst to change a steady flow to a flood. It does not matter that some European banks took big losses on sub prime paper. The fear of loss caused money to" flow to where it has been being treated best".

The dollar has fallen as a result of fear of additional loss in value. The selling of dollars reached the panic phase but has at least leveled off for now. The fundamentals do not matter to those who smell the stench of fear. After David slew Goliath, the Philistines sheathed their swords and ran away from farmers using garden tools and sling shots as weapons. Fear has rolled through several US real estate markets. Some resort properties have sold for less than half price because some people want out no matter what.

THE COUNTER FLOW HAS ALREADY STARTED

One group which has picked up on the "cheapness" of US assets has been the Canadians. Those who winter or vacationed on the Southern coasts have noted the powerful combination of falling real estate prices and the rising Looney. Many are taking advantage of this double whammy. The flow back this way is just a trickle so far but the pace will quicken. The buying power of other currencies has also shown up in the export - import numbers. US manufactured goods exports increased by 16.1% over the past year!

In just a few days, weeks or months, I expect the flow of funds flood to fully reverse. The aggressive money will lead the way, but once the Euro Central Bank follows the US lead with lower interest rates, the flood will include the return of tons of safe money. The bottom line is that the relative values of currencies is such a complex issue that the funds flows are reduced to momentum plays for the great majority of participants. The further a currency falls, the more eager the participants to sell. No one wants to get in front of a moving freight train. There is a train about to leave the station and you should make sure you are aboard.

Comments

[pendolino]

its easier to predict the trends persistence than the the inflection point in the forex arena i think. i would not bet on a change in the US dollar nor would i bet against it. be diversified.

[Rama]

You mention that the exports have increased by 16.1%. Still, our trade deficit goes down by a paltry 3% or so. At this rate it would require the dollar to fall by 50% to wipe out the deficit. Perhaps we have become too much of a hamburger economy that no one wants we produce!