Thomas MacLeod's  Instablog

In 2004 whilst giving a presentation on the outlook for the South African Rand to an audience of very influential South African exporters, a member of the audience popped a question to me that I will never forget.

He asked me, what would happen to the Rand Dollar if the US were to default on its debt?

Perhaps I had read Fooled By Randomness too many times because for some very strange reason this question has haunted me ever since. Surely the US will never default. Well maybe but they can pay you back in dollars that are effectively worth a fraction of their former perceived value! Perhaps this process is now underway. Perhaps!

There is no denying that there are elements of a currency crisis now present in the U.S. The US economy is running the biggest deficit since WW2, and a government committed to deficit spending on a grand scale. Spending that includes targeted stimulus that is sure to be misallocated. There are retirement programs that America can least afford along with a massive new healthcare initiative. Compound this with the US government’s affinity for short term fixes, a well established lack of fiscal responsibility and political will, and it is hard not to be concerned about a possible serious loss in confidence in the dollar.

As a contrarian I am well aware that shorting the USD appears to be a heavily one sided trade right now and if something didn’t tell me otherwise I might be inclined to bet on a bounce of some magnitude. However, I am also aware that history was written last year as far as sentiment goes, just when you thought things couldn’t get worse they did (remember the VIX at 90). It also does not take a rocket scientist to work out that just prior to the implosion of the German Mark after WW1 sentiment was probably rock bottom.

Yes one could always diversify into other paper currencies. But as luck would have it other fiat currencies offer few compelling alternatives.  European banks are in as bad (if not worse shape) than their US counterparts. China bears visions of Japan in the late 1980s and is out doing even the US in its expansion of its money supply. Japan has a quickly aging population, and declining exports and government debt three times worse than the US’s relative to GDP. To add salt to the wounds G20 nations have made it clear they are going to continue down the path of “stimulating” economies. Also bear in mind that in order to maintain competitiveness” nations are likely to attempt to weaken their currencies. Yes it all becomes a horrid feedback loop.

What was a credit crisis (call it what you will) is likely lead to a currency crisis and perhaps 2008 was only a taste of things to come as far as extreme movements in financial markets goes.

What will signal the engagement of a fully fledged currency crisis? It will be evidence beyond reasonable doubt that commodities have become the strongest currency in the world - yes a total loss of faith in paper currencies. Let’s define “beyond reasonable doubt” as being the CRB and Gold breaking to multi-week highs in AUD terms (currently the strongest of paper currencies). The currency crisis countdown is on!

CRB Index in AUDs

Gold in AUDs

We could think worst trading positions than being long the CRB in AUDs right now!

Disclosure: Long DBC TBT SLV