Shorting US bonds and abandoning the US dollar is just too easy to be the correct strategy, remarked Bill Bonner, President and Founder of Agora Financial at its 10th annual symposium in Vancouver last week.
Black Swan Capital was on hand to present an alternative scenario for the US currency which I thought seemed pretty convincing, although currencies are always the hardest call in financial markets.
The basic premise of this argument is the observation that when commodities and stock markets fall then the dollar is up, and vice-versa. What we have at the moment is a bear market rally and that has weakened the dollar.
But Black Swan Capital thinks we are in for a double-dip recession with the Chinese recovery story going horribly wrong and energy markets going into a fresh crisis. It sees a capitulation in emerging market stocks and an exit of cash, and a large risk of a European banking crisis, both of which would strengthen the US dollar and bonds as a safe haven.
The group points out that the model that sustained Chinese exports is dead, and that the Chinese surplus will therefore no longer be able to finance over consumption in Western countries. There will thus be considerable pain in emerging markets and huge stock market corrections.
China has been betting on a V-shaped recovery with $1 trillion in new loans in the first half of 2009 . This has created stock market and property bubbles that will collapse as the upturn fails to materialize. This is dollar positive. Japan tried a similar reflation of its economy in the early 90s and that failed.
That does not mean that precious metals will not fare well. It is unusual for the dollar and gold to rise in value against other currencies together but it is not impossible in very particular circumstances, such as a massive flight to safe haven assets.
Of course, if the Obama administration immediately responded to a further global crisis by printing more and more money then the dollar would ultimately weaken, but perhaps not until people felt comfortable about spending again. How long would that take?
The Japanese experience of lengthy deflation and stimulus packages in the 90s suggests it could take much longer than optimists think, creating an L-shaped or zero recovery.
This is of course precisely the Armageddon scenario that governments are working to avoid. But it would mean that holding onto US cash and bonds might not be as disastrous as the people rushing to buy equities that have already rallied too far seem to assume.