The Credit Crisis and the U.S. Dollar

First it was the Japanese financial crisis in 1991, and then came the Asian financial crisis in 1997 and the Russian crisis in 1998; now it’s Wall Street’s turn. The financial debacle in the US is no longer only a subprime mortgage issue; instead, the drying liquidity has spread the problem to many corners of the financial world including auction rate securities, bond insurers, and collateralized debt obligations.

On March 13, 2008 Standard & Poor’s reported that write-downs on subprime debt have likely hit the halfway mark and that the end was in sight. Yet, Bear Stearns (BSC) announced the following day that it had turned to J.P. Morgan Chase and the Federal Reserve for an emergency bailout sending the stock down by 47 percentage points. Exactly when the credit freeze will end is a question that no economist or financial analyst can answer at this point. A few analysts have reported the notion that this is the worst set of macroeconomic conditions since the Great Depression.

As a long-short trend trader, I invest where the market moves. It is important to realize that the market is not static; reversals can occur very quickly and an astute trader must be alert at all times and always be ready to get in or cash out. My trading style is based on a fundamental first, technical second philosophy. I fist analyze the fundamentals of the industry I’m interested in order to understand where the industry is headed, its performance versus the overall economy and a general understanding of its strengths and weaknesses. I then conduct technical analysis on companies within the sector to determine when to trade, based on my trading plan.

In this paper, I will discuss some of my trading ideas for the next few quarters in 2008, specifically taking a macroeconomic viewpoint. The discussion will aim to dissect the major trends with the economy, and a discussion of where I think some of the cyclical plays are within these sectors.

The markets for discussion include the US dollar, Precious Metals, Financial Services, Retail & Consumer Packaged Goods and Real Estate.

Weakness In The US Dollar
The US Dollar has been in a secular bear market for several years - it has depreciated by over 35% versus the Euro over the last five years. The government controlled media is finally beginning to raise voices over the economic problems that alternative media have been talking about for years. The United States is facing an inflationary depression, and this trend will likely not ease any time soon. Independent studies have shown that the M3 money supply – the entire money within an economy, has been seeing annual increases of around 16-17%. The Fed stopped publishing M3 numbers in March 2006, around the time when the numbers began skyrocketing.

The increase in money supply is one of the underlying reasons for the devalued currency. The US dollar index – a benchmark of the USD to a basket of foreign currencies, has decreased from the 80’s to the low 70’s over the past year.

Global Confidence In the USD Eroding
It is becoming increasingly clear that the world’s reserve currency is shifting from the USD to the Euro and commodities. The question on the minds of most investors is if the US dollar will continue to decline and if so for how long. Weakness in the US Dollar has been accelerated due to poor economic data. According to recent data released by the Federal Reserve and the US government, home owner equity is at its lowest levels since 1945, consumer debt has grown to $2.52 trillion and unemployment levels are at its highest levels since 2003. Furthermore, it is rather disturbing to know generally that statistics published by the Federal Reserve and the US government understates economic problems; so the recent economic data may indeed be worse than what was published by these two parties.

This economic data has created much fear in the economy, which has sent many investors seeking safe havens in other currencies and commodities such as the Euro, oil and gold. The Consumer Sentiment Index from Michigan University and a leading indicator of economic recessions has been declining since early 2007. As consumer and investor confidence in the United States continue to weaken, more investment will pour out of the country, causing the dollar to slide even more.

In addition, as the value of the real estate asset base that was used as collateral to support the massive issuance of credit over the past few years becomes further destroyed, the lack of credit will continue to cause the Federal Reserve to cut interest rates and print more money which will send the economy into a hyper-inflationary state. It is scary to think that it was only 15 years ago, that Japan underwent a very similar real estate bubble, financial crisis and economic recession that the United States is going through now.

However, what seems to be forming in the US economy is a vicious cycle, forcing the value of the US Dollar to decline:

1. US dollar declines
2. Investor confidence drops
3. Housing declines further
4. Investments are pulled out of the country
5. Banks go insolvent
6. Widespread job losses
7. Decreased consumer spending
8. Fed cuts interest rates
9. Monetary easing as the central reserve prints more money
10. Increase in inflation
11. Us dollar declines

As the economy continues to weaken, interest rates continue to decline, inflation continue to skyrocket and the money supply continue to increase, it seems inevitable that this perfect storm will continue to drive down the value of the US Dollar. What this means for investors is in the coming months, there will be plenty of opportunities to short the US dollar, long foreign currencies and long commodities such as oil and gold.

Disclosure: None

Comments

[locke]

Lots of bold claims and nearly no evidence or references. Try harder next time, shorty.

[richjoy]

Frankly, I stopped reading when I got the to reference to our "government controlled media"...

Sorry Mr. Sun, but if you have something of interest to me, you have to start with credibility.

[crowdofcheerleaders]

this was a great article. and bravo for mentioning the alternative media. imagine how much money people could have saved if they were listening to it. thumbs up dawg :)

[SIMPLE d]

rich, don't be naive. mainstream media isn't controlled? you honestly believe the US mainstream news is objective and propaganda free?

ha.

Sun, expect to get burned when you come with some truth.

But what are you proposing? What can be done?

Exposing the Fed and the complete lack of needing a fiat currency....is i guess in part what you're trying to do...you could satiate locke with some references.

Probably the best bet for anyone interested in maintaining wealth currently held in dollars and certain sectors is to get out of the USD and into essentials, yep. I agree.

...What would happen if we just burned 1/2 the money in print? Massive depression... although the economy can self-correct following this; we could carry it out over several years...?

We are being made into techno-serfs while simultaneously being told and believing everyday we somehow have more freedom. We are told we have capitalism when in fact we do not. Likewise for democracy.

If it wasn't for years of conditioning desperately clung to, i'd like to believe the other two prior commenters could read and digest what you wrote here.


Nice article.

[GaryD]

Hey richjoy, I've got a bridge for sale. Excellent location. Great opportunity to earn toll revenue.

[User 165546]

Nice article but I think your of the mark with a couple of your assumptions. Firstly the Japanese financial crisis was not about inflation but deflation. It was the fact that all assets, real estate stock market etc declined so quickly and were so highly geared that has led to the very high savings low consumer spending economy we see today. Japanese balance sheets are fat and unproductive but that is conditioning from years of slow growth and relentlessly paying down debt. The Fed is painfully aware of this and in fact it has been preaching to Japanese authorities for years to try and change policies. They are now staring down the barrel of the same problems. Yes the fed has cut rates and yes it is printing money but it probably isn't compensating for the monetary destruction brought about by the collapse in the fixed income derivative markets.

Secondly you are correct to point the fall in the value of the dollar as an important sympton of the monetary demise but rather than extrapolate an ever lower dollar think of it from a Euro/Gold investor's point of view. Atrractive US assets are becoming historically very cheap. Evidence of this is the willingness of foreign soverign wealth funds to buy into stricken US Investment Banks, high risk but historically very profitable trades. Sooner or later foreign capital is going to be attracted back into the US economy and the dollar slide will at least halt if not actually reverse.

So instead of being gloomy about the future look to the upside, improving terms of trade should make US exports comparatively cheap. Import substitution should be back on the table, look to bring some production back onshore. The Japanese are actually now building new car plants in Japan for the first time in 20 odd years! Higher food and commodity prices are much more of an issue for the developing world as they are a larger slice of input costs compared to wages. So don't knock inflation you do actually need some in order to continue to grow the economy. If the dollar does pause in it's decline the long commodities trade might not be so profitable for you for a bit.

[crowdofcheerleaders]

the dollar would not only have to halt, but then appreciate considerably if it were to catch up to the personal income destruction it has already caused. as for industry coming back to the U.S. due to weak currency, i'm all for industry coming back. but it's not going to pay like the industry of old. instead it's going to pay like industry does now in China and India, which is pretty depressing to say the least.

[Tracker]

Heresy! You should be burned at the stake! I have a Ph.D. in Economics and I've never heard such a load of B.S. We're just experiencing a... uh.... a slowdown. Yeah, that's it. Don't worry, the Fed and the IMF will bail us out, and we'll be back on our feet in no time.

;)

[MoralHazards Amok]

Good article, Howard. I don’t know exactly what you mean by "government controlled media" but intelligent people do understand that the US government isn’t being honest about inflation and plays this game of “core” inflation and “headline” inflation and tries to tell us that real inflation really isn’t too bad.

Yea, right, Uncle Sam. We all know the serious consequences of paying government retirees and SS recipients their real cost of living increases.

Batten down the hatches. It’s going to be rough for a while.

[User 142738]

There are so many weasel words and phrases (“government-controlle... media,” for one — would love to see some proof of that) in this article that it’s hard to see what investment this author is promoting. The title itself is supported by about two paragraphs, and the investment strategy being promoted is only revealed in one short sentence at the end of the article.

He may as well be selling a position with some listing on Pink Sheets.

[johnthebear]

Some folks are allowing a few stray ideas and conversation to divert attention from the reality that the author is trying to express.

I agree with the author and he has my sympathy!

It is not popular to be a prophet!

In Bible days, the prophets were always killed!

Watch your back, the bulls have no mercy in trying along with the big media to prop up the market. How else do you explain the sharp pops on the smallest trace of positive news, while ignoring the trends in stock indexes all over the world that are trending lower and have been for the last 6 months? They are all below their 200 day moving average. The market is so foolish. Now the media is insisting on making the China-emerging market bubble even bigger than it already is! I keep hearing they need to put 20% in these declining markets, simply because they don't know what to do with their cash. Better try bank accounts with $100,000 insurance or else be short and own GLD.

I invest in ultra short Dow Jones Real Estate index (IYR) using the ProShares: SRS an exchange traded fund that is 2:1 up/down. I am "all-in" on the short side, but may do some trading on the bull side dead cat bounces like we recently endured for short term profits. The big picture will be bleak for the next few years. Better to protect yourself as suggested by the "Prophet."

[sedek]

Interesting piece, especially "government controlled media." I've noticed that it has only been in the last few months that anyone in msm has noticed the relationship between falling Dollar and skyrocketing commodity prices or has made the connection between liquidity injections/rate cuts and the tanking Greenback. I doubt msm is taking direct orders from the the administration, rather is afraid to accurately report.

As for your sequence, I see it as:
1: Subprime lossses threaten banks.
2: Bernanke devalues currency to socialize bank losses.
3: Commodities rise.
4: Discretionary income is constricted.
5: Congress passes more tax deferments and bailouts.
6: Dollar devalues.
7: Commodities rise.
8: Etc.

I like commodities long and see short term trading opportunities in currencies, but would be careful with the Euro, as ECB is also devaluing. Gold and the other metals are real money, fiat currencies are no more than raffle tickets.

[mikeee]

The article is concise and accurate. The conclusion is good judgement. In addition there are many, many more large negative factors affecting the demise of the dollar not mentioned. It is much worse than projected. The consequence of 50 years of economic irresponsiblity is resulting in an exponential demise in the next couple years.

[flow5]

All of you are wrong. The current account deficit is driving the dollar lower. It is also driving commodities higher. The dollar has lost 37% to our major trading partners since Feb. 2002.

Devaluing the dollar is NOT a cure. If we don't sell higher quality and lower cost, goods & services, the dollar will continue to slide. We will eventually operate within a command economy and be driven into a totalitarian mold. It is inevitable.

[iThinkBig]

Couple comments on Mikee and Flow5. Both are correct. For Mikee, the fact is, we have not had to compete in a global competitive environment and Bush Sr, Clinton and Bush Jr. politics that our trade partners will 'balance' out in the end has been fallacy. Trade partners can add a glut of top-line revenue but that revenue has to be applied toward the entire population's wealth growth. The top-line revenue from globalization was applied to the top 3% of our population with no support policies in recent job creation (since tech bubble). The way out is to innovate into energy and create a real competing product vs. petroleum. No one alternative energy will work, it energy indepenence demands a) Government/Treasury subsidies with the millions of service level jobs created as the benefit to the poor and middle class b) job training programs c) regulations that prohibit lawmakers and there families from investing in energy period until 2 years after they are out of office.
See the political will to do the above? I don't and that means we must likely see a giant wave of Socialism (see recent financial bailouts whether 'necessary' is another question) and the entire system failing and then Patriots run for office.

[RobertTrudeau]

Screw Ron Paul.

[RobertTrudeau]

Inflation to save the economy, then deflation to save it. The difference this time is the extemes it will take. I hope Bernake's helicopter is full of gas and ready to take off. It is interesting that the US is now counting on the global economy to save us versus the other way around. Long live multi-nationals, bring those profits home!