Stand by Your Buck
Investors and economists disagree over whether the stock market's rebound is for real and whether the worst is over for housing. But most of the chattering class seems to agree that the dollar's stature in the world and its purchasing power are in peril. One hell of a chorus is shouting that every Federal Reserve note could lose 30% or more of its value against various foreign currencies in a few years, a casualty of huge government deficits and the relentlessly high inflation that is supposedly destined to result.
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And that's not all, they say. The United Nations council on trade and development is calling for the establishment of a new global monetary unit to serve as the world's primary reserve currency. That would end America's privilege of creating money by selling enormous volumes of Treasury debt to foreign buyers. Think credit is tight now? Just wait.
Relax, folks. This dollar-bashing is exaggerated. The buck will prove more durable than you think. The same epitaphs were written ages ago, when the U.S. dropped the gold standard and, more recently, when Europe invented the euro. I want to stress that I am not engaging in thoughtless flag waving (nor am I trying to prop up the dollar so that I can scarf up foreign real estate on the cheap). I also do not expect the dollar to be almighty everywhere and forever. Fast-growing nations, such as Brazil and India, and resource-rich countries with budget surpluses, such as Norway, deserve stronger currencies.
Some critics of the greenback, including those who breathlessly hawk gold (after it's already soared in price) and authors of books with such titles as The Dollar Meltdown, are plainly promoting their own interests. But it's also common to see references to the sick buck in mainstream investment advisories. For example, Larry Adam, chief U.S. investment strategist for Deutsche Bank Alex. Brown, recently cited the grim outlook for the dollar as a reason to invest aggressively in Asia and in U.S. tech and industrial companies (the latter group because a weakened dollar would make their products more attractive to overseas buyers).
I called Adam to clarify whether he was suggesting that the dollar would weaken sooner or weaken later. But he said he doubts the dollar will deteriorate any further against developed-nation currencies, such as the euro and the yen. As long as Americans continue to "de-lever" -- that is, save more and borrow less -- "we've seen the bulk of the depreciation in the currency," Adam says.
Jeffrey Gundlach, chief investment officer of the TCW mutual funds, goes further. He predicts a "monster dollar rally." He says that investors around the globe are well aware that the Treasury is borrowing trillions, but they also have concluded that inflation is going nowhere, so there's no reason to fear holding cash savings or other investments denominated in dollars. Gundlach also observes that the dollar has held up well since the death of Lehman Brothers a year ago, an event that some pundits say signaled the beginning of the end of American capitalism.
The ICE U.S. Dollar Index Futures, which measures the dollar against a basket of currencies, is even since Lehman blew up and the credit crisis exploded in September 2008. The index is 8% above its five-year low, reached in April 2008. This is the case despite the Federal Reserve having cut short-term interest rates so low (essentially to zero) that even a boneheaded trader can profit by borrowing U.S. dollars, selling them and using the proceeds to buy higher-yielding government debt denominated in yen, euros or other currencies.
But that's a technical play in the markets. It is not convincing fundamental evidence that the dollar is dying or even that it's chronically ill. And because the dollar really isn't a basket case, its exchange rate will rebound once the Fed tightens credit, which it is likely to do starting in 2010.
Something old? Now, let's ponder the dollar alternatives. You can rule out the euro and other old-world currencies as candidates to become the world's new reserve currency. All the knocks on the dollar -- Americans' high personal debt, soaring government budget deficits, slow economic growth, unfunded obligations to Medicare and Social Security in an aging society -- are even more pronounced in countries such as England and Japan.
The yen has had a solid run and the euro is trading near a one-year high versus the dollar, but their strength is not sustainable, says Jay Feuerstein, chief executive and chief investment officer of 2100 Xenon, a Chicago futures-trading firm. Rather, the euro and yen have run wild "because we have the lowest interest rates on the planet," he says. Once the Fed decides that the economy is on the mend -- chairman Ben Bernanke has already suggested that the recession has ended -- and starts to raise rates gently, the dollar should strengthen. Longer term, says Feuerstein, the relative strength of the U.S. economy will boost the dollar: "When things get really good in the U.S., the dollar is the place to go."
There's speculation that the Chinese yuan, also called the renminbi, could become the main reserve currency because China's economy keeps expanding vigorously and China has surplus cash, including $1 trillion in U.S. Treasury debt. But for the world to trust the yuan as a store of wealth, China would have to remove all controls on currency movements, including its ban on foreign ownership of Chinese government bonds.
China would also have to make the yuan fully convertible into other currencies and allow its value to float. That would undoubtedly boost its value against the dollar in the short run, but it would put the hurt on China's export-driven economy (because Chinese goods would become more expensive for U.S. consumers) -- and trim the value of all those dollar-denominated Treasuries. Most of all, China's closed, undemocratic society disqualifies it from serving as the world's chief financial market.
Something new? What about an "Esperanto" currency, as the United Nations proposes? The U.N.'s idea, which is nowhere near an official vote, is murky. Partly, it's rooted in the hope that developing countries would find it easier to manage their debts if they could borrow in something other than dollars. The U.N. also delves into politics, slapping the U.S. for loose regulation of mortgages and financial speculators, and connecting the Wall Street crisis to the inflated fuel and food prices of 2008 that hurt poor countries way worse than rich ones.
There's no sense of how the world would prepare for this change. It took the European Union years to adopt the euro, and several members (most notably Britain) rejected it. Washington's Peterson Institute for International Economics calls the idea of a new U.N.-sponsored world currency a nonstarter.
Something shiny? In truth, some dollar bears aren't interested in another currency. They espouse restoring the U.S. and the world to the gold standard. Their argument is that this would prevent high inflation. Gold is popular with investors as a diversification tool. I have no problems with that.
But there's nowhere near enough gold to absorb all of the world's savings currently held in dollars, not to mention euros and other units. Other commodities would probably make more sense, anyway, because everyone needs oil, corn, wheat and water, while gold itself has no essential use (unless you consider bling essential). And, unlike gold, oil and grain prices are well below their 2008 highs, a key reason that inflation is virtually nonexistent.
There's always a window for traders and speculators to gang up on the dollar, just as they occasionally do on Treasury bonds. That explains why you'll see headlines with words like carnage and crushed when the euro rises for a day and the dollar dips.
But to keep beating down the buck because of concern about U.S. government spending when most of the rest of the developed world suffers from the same problems is illogical. I think it's wise to buy a foreign bond fund for diversification and for income if it yields more than a comparable U.S.-oriented bond fund -- but don't do it because you're scared of the dollar. George is not going down for the count.