The fact that the market is looking increasingly "crash-prone" is indeed old news. Just take a look at virtually any financial sector, and in particular, the banking index [$BKX], and you could argue that we have already seen a crash or two. That said, whether you agree with the government's recent actions or not, one of the more frightening "crashes" that we are witnessing could well be the ongoing debasement in the U.S. dollar.
I am not much for fear-mongering. I take an old-fashioned, stock-picker-esque approach to the markets. Nonetheless, we are in the grip of a ferocious bear market decline and as such investors need always look over their shoulder for the next shoe to drop - and that could well be the effect of a spiralling U.S. dollar on the countries that are pegged to it, especially countries experiencing the excruciating pinch of rampant inflation.
The countries primarily in the eye of the storm are China, Saudi Arabia, Hong Kong, the United Arab Emirates, and Singapore, though there are clearly others at risk at well. We will focus on these countries simply because they present ways to play this potential crisis.
First consider that each of these nations are facing inflation problems, to put it mildly - China and Saudi Arabia most notably. When you are faced with 8-10% inflation or more, being pegged to a declining currency isn't much fun. Sure, the peg allows for certain advantages - namely exports. But it also means that you are increasingly paying more for goods overall, with little currency benefit to off-set the pain.
Further consider that we (the U.S.A.) are in an election environment where we seem hell bent on bailing out a large fraternity of negligent financial institutions who have sewn themselves into burlap-size sacks of distress. The majority of the "plans" being put forth would involve draping the U.S. taxpayer further with debt, further putting pressure on the U.S. dollar. While the effects of this on the U.S. taxpayer are important concerns in their own right, and deserving of perhaps a column all of their own - the continued by-product of our own systemic financial woes is the weak dollar itself, which hurts the global landscape in inflationary terms by this continued pressure on key international financiers and commodity producers (Saudi Arabia) and commodity consumers (China), who have pegged their currency to ours.
The irony is that while we can wonder all day long why it is so necessary to bail out these sick financial institutions of ours, and whether or not some of them (or all of them, for that matter) deserve to fail - there is no question that some of the largest holders of the debt of these companies, and of our own treasuries, is - guess who - China and Saudi Arabia. So who is helping who here?
What therefore seems indisputable is that we are paying off the sins of Wall Street, to the benefit of foreign nations, who - strangely enough - will be hurt in the long run for it all, unless they unhitch their ride from the sickly U.S. Dollar, which will hurt our status as "lead dog" and potentially derail us from our pre-imminent role as leader of the economic world.
This is where we get to the fear-mongering. With the credit and banking crisis screaming to new levels of fear and loathing almost daily, it worries many investors to think that they may wake up one morning to the headline that China has de-pegged from the U.S. Dollar out of necessity, to control their own rampant inflation. This would create a ripple effect across the currency markets worldwide. Given their close business ties with both the U.S. and the economic dynamo that is China, Saudi Arabia, Singapore and the other aforementioned pegged countries would seemingly have little choice but to clip their own pegs shortly thereafter. What would happen next would be a sheer act of nature, with the rebalancing of the currencies of these various nations as they fly higher, and the poor, lonely U.S. dollar likely sliding further into acrimony.
While we could go on to describe the sad consequences of being a nation burdened with debt and no longer able to drag other nations down to our level, fiscally speaking, so that we could pay it off - it seems more sensible to discuss the ways in which investors could benefit from this proverbial "next shoe that might drop."
There are two ETFs that try their best to track the currencies of these countries. Wisdomtree's (CYB) is an ETF that directly attempts to track the Chinese Yuan. Given that the Chinese government has already tried to let the Yuan rise a bit, this ETF may actually give a slight to decent return while one waits for a possible "de-peg." It rose substantially earlier this year, before slacking off a bit in the second quarter.
The other way is Barclay's (PGD), which tracks both the Yuan as well as the Saudi Arabian riyal and the Singapore dollar, among others. This method costs you 0.89% in expense ratio, which may or may not be off-set by any rise in the Yuan, meaning you get basically a flat return while you wait for the great currency domino trade to trigger - or not.
Both of these instruments are relatively new, and therefore investors considering them should also factor in their limited trading histories when making their decisions. Gold is an acceptable alternative to this strategy, given its status as the "flight from fear" play - or as a complementary position. But gold has more downside should the U.S. Dollar wake up from its terminal state for some reason and rally.
The general notion however is that these currency plays should offer relatively low-risk returns with superior upside potential should any de-pegging efforts actually take place. At this point, judging by the rise in the price of gold, and the overall market, one has to stretch the imagination to find some way out of this current mess. But that's not to suggest that there isn't one. Slowing global growth presents its own salve. The question is whether it occurs in time to save the long-standing U.S. Dollar peg that many of the world's nations have clung to blindly for the past several decades.
And of course, nothing could happen. The U.S. dollar could rally, and you could receive virtually no return for your trouble.
Disclaimer: The author maintains positions in the GLD, the ETF that tracks the underlying price of gold, as well as CYB and PGD.