is the u.s. dollar a "buy"?

[jk]

i, like so many others, have held a bearish view on the dollar for some time, and i currently have 64% of my assets [including the effect of leverage] in "non-dollars," including foreign currencies and foreign currency bonds, canadian income trusts, energy assets, and precious metals. john mauldin's latest "outside the box" is a piece by gavekal, entitled "the leverage in the system and the weak us$." it is available at:

http://www.investorsinsight.com/otb.aspx

although i don't agree with every step of their reasoning, they make a powerful argument for a potential steep rise in the $. although they don't quite say so, the trigger for this would be a u.s. slowdown/recession.

many analysts have been predicting a u.s. slowdown and possible recession for later this year. the common assumption, i believe, is that a slowdown will accelerate the dollar's decline by making u.s. assets less attractive. but a slowdown will reduce the current account deficit, which would tend to support the dollar.

the article points to a parallel in the 1970's-80's. certainly the current period is reminiscent of the 70's- an oil shock, inflation rising, the dollar weakening. when volcker came in and raised rates, he started strangling the inflationary process, and the dollar rose enormously until the plaza accord of 1985.

i think [but i'm not sure] the parallel breaks down. does anyone think bernanke's path will follow volcker's? is bernanke determined to strangle inflation and raise rates until inflation is clearly diminishing? will our coming slowdown/recession be accompanied by historically high interest rates? after all, volcker kept rates high right through the double recession of 1980-1982. or will bernanke drop rates like a hot rock at the first clear signs of systemic weakness?

IS THIS ENOUGH OF A DIFFERENCE TO UNDERMINE GAVEKAL'S ESSENTIAL ARGUMENT? or will a slowdown/recession, in itself and without the maintenance of high interest rates, cause the dollar to rise? [also, is there a connection between this question and the thread about whether a dollar crisis can be deflationary?]

[blazespinnaker]

my understanding is that a slowdown will decrease the odds of a fed rate hike which means that treasuries will be less attractive and so therefore less buying of the USD.

if the fed continues to rate hike then the dollar will do fine, I think. you might say that this would be counterbalanced by a sell off in US equities, however the world wide equity market is dependent on the US in a lot of ways ... so all markets will drop if the fed hikes and their will be no real flight to safety, except the US treasury bond.

(I think the reason buffet bailed from his currency hedge is because a) he was doing something that really isn't in his sphere of expertise (tich tich) and b) someone pointed out to him that the a volker like fed could hike the funds rate and his bet could hurt berkshire in a very big way.)

So I'm not really short on the USD, and in fact, by holding major amounts of canadian I'm a bit long on the USD because we're so tied into the US economy ..

My thought is that we all missed the USD bear market and it's too late to be short. We should have bought gold and housing just after greenspan reduced the fed funds rate to ludicrous lows. such an obvious play in retrospect.

However, the point is, the damage is done. Now we have a new chairman and they are paying the piper, which means they have to naturally defend the dollar.

the conclusion? As long as the fed continues to rise, I am neither long nor short on the USD. However, if we fall into recession and the fed stops raising or even considers loosening monetary policy I will most likely become more bearish on the dollar.

[blazespinnaker]

and I can't predict what the fed will do long term. that's really hard. my guess is that they do not want to kill the US economy but they don't want major inflation either, because that becomes self perpetuating.

assuming oil/previous monetarist policies show up in the inflation numbers and the fed doesn't start talking about 'inflation minus rental rates', I am pretty sure the fed will hike even it means driving the economy fully into recession.

[jk]

would the fed tolerate a u.s. recession?

i don't think the fed is as strongly committed to inflation fighting. actually, given current realities, which is to say current debt levels, i don't think i want them to be that strongly committed to inflation fighting. a recession with all the debt overhang could spiral into a disastrous deflation.

the only solution is inflation, actually. inflate away individual debt. inflate away all those markers being held by the chinese and japanese and middle eastern oil suppliers. the japanese bought rockefeller center and pebble beach at the top. it looks like they've bought dollars not at a top, but it will look like one compared to what lies ahead.

[blazespinnaker]

Inflating leads to a loss of confidence in the USD which leads to a devaluation of the currency .. which leads to more inflation. A potential hyper inflationary death spiral.

Deflation doesn't really have a feedback looop that I can see, but perhaps you can educate me. well, no, that's not true.

deflation has the classic feedback loop of people stop spending which leads to a deeper recession .. however, in that case, the fed can just stop hiking.

the loss of confidence is a very difficult thing to claw back from. getting out of a deflationary spiral is relatively more easy,I suspect.

at the end of the day, the fed is appointed for 14 years. they don't need to pander to the electorate and can make decisions based on what they feel is the long term right thing to do rather than what seems convienent at the moment.

[jk]

deflation risks and feedbacks

Inflating leads to a loss of confidence in the USD which leads to a devaluation of the currency .. which leads to more inflation. A potential hyper inflationary death spiral.

Deflation doesn't really have a feedback looop that I can see, but perhaps you can educate me. well, no, that's not true.

deflation has the classic feedback loop of people stop spending which leads to a deeper recession .. however, in that case, the fed can just stop hiking.

the loss of confidence is a very difficult thing to claw back from. getting out of a deflationary spiral is relatively more easy,I suspect.

at the end of the day, the fed is appointed for 14 years. they don't need to pander to the electorate and can make decisions based on what they feel is the long term right thing to do rather than what seems convienent at the moment.

deflation is probably harder to get out of than inflation. with inflation you need the political will to hike rates high enough and then the will to keep them relatively high in spite of the economic pain of the recession you'll induce. it takes guts, but it's straightforward.

in deflation you not only have the feedback loop of expectations, you also have the vicious cycle of defaults and bankruptcies. most of the assets we hold are someone else's liability. if that someone else goes belly up, get in line for much delayed partial payment. in the meantime, perhaps you can't service YOUR debts, so you default on your creditors, etc.

the fed will liquify all the banks to avoid a repeat of the bank failures of the 1930's. will fdic cover deposits over 100k? maybe, maybe not. will they start buying non-traditional assets-- longer rated bonds, equities, real estate, porcelein figurines? if they have to. they'll fire up the helicopter if they HAVE to. but it would be a delicate matter.

when japan tried this with their quantitative easing after their zero interest rate policy failed, japan had to liquify the whole world to finally get a spark in japan's engine. and if people and institutions have already gone bankrupt, it's going to be a little late.

japan didn't have the debt structure we do. so if WE head into deflation watch out! think of all the derivatives blowing up in chain reactions, mortgage defaults, credit card defaults, margin calls, forced selling of assets at low, low prices [a good time to have cash, blaze]. anyway, there can be an incredible amount of damage. that's why i think they will always ultimately choose inflation -- to the degree that they're in control. there's always the possibility of a miscalculation.

as to the independence of the fed, that was certainly a joke during the greeenspan era. he made his "irrational exuberance" speech in '96 with the dow about 6000. when the markets and the politicians got upset he became a cheerleader for the "NEW ERA"! he could have raised margin rates to cool things off a bit, but he didn't have the nerve. he wanted to be loved, "the maestro" indeed! i think he will be excoriated by history after the chickens come home to roost.

[blazespinnaker]

I have to agree with HeliBen I'm afraid, the fed can just fly around and throw money out of helicopters.

Not only would this work, but it doesn't require much in the way of political will...

I guess we'll see what happens. Right now the odds of a recession aren't that high so there is room to hike the rate still.

[jk]

timing - financial processes are not instantaneous

certainly the fed could turn the dollar to confetti much more quickly if it wished. the problem is one of timing. we have to give up the implicit assumption that all processes occur instantaneously. yes, the fed could drop money from helicopters. but it won't do so lightly or easily. what processes will have ALREADY OCCURED before they fire up the helicopters?

historically there has been a financial crisis that triggers fed easing. from penn square [who remembers that?] to continental illinois to the crash of '87 to russia's default to ltcm to the bear market of '01-'02,* something happens that tells he fed enough is enough. and, as warren buffett is fond of saying, you don't know who's swimming naked 'til the tide goes out.

bankruptcies and defaults don't get undone just because the fed decides to ease.

* may i recommend derivative strategy comix? here's a link to my favorite:
http://www.derivativestrategy.com/ma...mix/0005_1.asp

[Jim Nickerson]

No response at your link.

certainly the fed could turn the dollar to confetti much more quickly if it wished. the problem is one of timing. we have to give up the implicit assumption that all processes occur instantaneously. yes, the fed could drop money from helicopters. but it won't do so lightly or easily. what processes will have ALREADY OCCURED before they fire up the helicopters?

historically there has been a financial crisis that triggers fed easing. from penn square [who remembers that?] to continental illinois to the crash of '87 to russia's default to ltcm to the bear market of '01-'02,* something happens that tells he fed enough is enough. and, as warren buffett is fond of saying, you don't know who's swimming naked 'til the tide goes out.

bankruptcies and defaults don't get undone just because the fed decides to ease.

* may i recommend derivative strategy comix? here's a link to my favorite:
http://www.derivativestrategy.com/ma...mix/0005_1.asp

The link you put in doesn't seem to work, is it me or the link?

[Jim Nickerson]

Call for more discussion on this topic.

i, like so many others, have held a bearish view on the dollar for some time, and i currently have 64% of my assets [including the effect of leverage] in "non-dollars," including foreign currencies and foreign currency bonds, canadian income trusts, energy assets, and precious metals. john mauldin's latest "outside the box" is a piece by gavekal, entitled "the leverage in the system and the weak us$." it is available at:

http://www.investorsinsight.com/otb.aspx

although i don't agree with every step of their reasoning, they make a powerful argument for a potential steep rise in the $. although they don't quite say so, the trigger for this would be a u.s. slowdown/recession.

many analysts have been predicting a u.s. slowdown and possible recession for later this year. the common assumption, i believe, is that a slowdown will accelerate the dollar's decline by making u.s. assets less attractive. but a slowdown will reduce the current account deficit, which would tend to support the dollar.

the article points to a parallel in the 1970's-80's. certainly the current period is reminiscent of the 70's- an oil shock, inflation rising, the dollar weakening. when volcker came in and raised rates, he started strangling the inflationary process, and the dollar rose enormously until the plaza accord of 1985.

i think [but i'm not sure] the parallel breaks down. does anyone think bernanke's path will follow volcker's? is bernanke determined to strangle inflation and raise rates until inflation is clearly diminishing? will our coming slowdown/recession be accompanied by historically high interest rates? after all, volcker kept rates high right through the double recession of 1980-1982. or will bernanke drop rates like a hot rock at the first clear signs of systemic weakness?

IS THIS ENOUGH OF A DIFFERENCE TO UNDERMINE GAVEKAL'S ESSENTIAL ARGUMENT? or will a slowdown/recession, in itself and without the maintenance of high interest rates, cause the dollar to rise? [also, is there a connection between this question and the thread about whether a dollar crisis can be deflationary?]

To expedite anyone wishing to read The Leverage in the System and the Weak US Dollar by GaveKal Research, look for this title just below the date near the upper right hand corner of the page. I think eveyone should read this article.

From what I can personally piece together, jk knows a lot about economics and a lot of, or perhaps most of, his thought processes are way over my head, hopefully this isn't true for anyone else visiting these pages. I do not comprehend, after studying and being tutored, everything in Gavekal's article, but if the premise is correct that the guys at Gavekal are "smart cookies," then to my understanding their conclusion

" As far as the oil producers are concerned, they are getting far more dollars than they expected. So they diversify these excess dollars either irrationally, or rationally. But they do not realize that a lot of the dollars that they are getting are not "earned" dollars, but "borrowed" dollars (see the increased indebtedness of Chinese companies, or individuals in US dollars as an example). As a result, US assets have underperformed the rest of the world assets for no valid reason at all. As soon as the flow of money to these countries will dry, the US assets will go up versus the other assets. This is a very good opportunity to start accumulating assets with positive cash flows in US dollars.

were it to be correct has, as I see it, grave bearing for those who are bearish right now on America--and I am one who is.

I think there needs to be a whole lot more of serious discussion about Gavekal's conclusion. This may come across as my doubting jk's wisdom. I have no such doubts, but as he perceives flaws in Gavekal's arguments, there may be flaws in his arguments, and I certainly am not capable of resolving the difference in how he sees things vs. how Gavekal sees things.

I cannot get over the fright in me caused by lots of people thinking the same way about how something in a market may behave. I just abandoned a position on the US$ getting stronger, based on the strongly diverse opinions that exist right now about what the US$ may do, even though the charts of the UD$ have put in a rather classical reverse head and shoulders formation--which suggests the US$ is going higher--this would tend to support GaveKal's thesis. My abandoning my long position on the US$ is totally insignificant, but if Gavekal's rationale were to prove correct, and from what I can surmise it is highly contrary at the moment, it would burn a lot of bears. The latest sentiment numbers I have seen suggest there are a lot of bears now.

Can anyone see GaveKal being right on this issue?

If I am adding redundacy to this discussion, I apologize.

[jk]

derivative strategy comix link

try:

http://www.derivativesstrategy.com/magazine/comix/

my favorite is the series called "memorial day."

[jk]

I cannot get over the fright in me caused by lots of people thinking the same way about how something in a market may behave. I just abandoned a position on the US$ getting stronger, based on the strongly diverse opinions that exist right now about what the US$ may do, even though the charts of the UD$ have put in a rather classical reverse head and shoulders formation--which suggests the US$ is going higher--this would tend to support GaveKal's thesis. My abandoning my long position on the US$ is totally insignificant, but if Gavekal's rationale were to prove correct, and from what I can surmise it is highly contrary at the moment, it would burn a lot of bears. The latest sentiment numbers I have seen suggest there are a lot of bears now.

re the head and shoulders - the dollar index would have to rise to 92-93 to make the pattern. click link below:

$USD - Monthly Candlesticks, 780

http://stockcharts.com/c-sc/sc?s=$US...76122725&r=313

i too worry when a position gets too popular, but i think the recent back up in the dollar may have taken care of that problem.

i think the dollar rises in a deflationary scenario, or if the economy is a LOT stronger than anybody on this board is thinking.

i think that gavekal is a bunch of clever thinkers, but they've been positive on the dollar and on u.s. equities for at least a year, and to date they've been wrong.

[Jim Nickerson]

re the head and shoulders - the dollar index would have to rise to 92-93 to make the pattern. click link below:

$USD - Monthly Candlesticks, 780

http://stockcharts.com/c-sc/sc?s=$US...76122725&r=313

i too worry when a position gets too popular, but i think the recent back up in the dollar may have taken care of that problem.

i think the dollar rises in a deflationary scenario, or if the economy is a LOT stronger than anybody on this board is thinking.

i think that gavekal is a bunch of clever thinkers, but they've been positive on the dollar and on u.s. equities for at least a year, and to date they've been wrong.

I looked at that chart as or before I wrote my comment and I know the die has not been cast. Today's action in the US$ squelched it.

I am too tired to search for specifics, but as local example that I hope I am not misrecollecting, EJ was calling a top in the markets a good while before they topped out in 2000, he was buying gold when a lot of people thought it trash, and I think, perhaps wrongly, he also was in effect shouting "fire" in the housing bubble a good while before things began to unfold, as it seems they now are. EJ may comment to correct me if I'm wrong.

I am not wed to GaveKal being right, perhaps they are early as you were with your shorts on housing, if I remember that correctly.

[jk]

I am not wed to GaveKal being right, perhaps they are early as you were with your shorts on housing, if I remember that correctly.

you're right, and they may turn out to be right. that's why i'm 50-60% antidollar instead of 100%. and that's why i still want to pay attention to those guys. i respect their thinking even if, so far, i remain unconvinced of their conclusions.

[S]

Disasters, etc.

If the Fed normally eases in response to a crisis, what role might hedge funds play in the next crisis?

I'm a rookie - so I'm just asking brighter minds here.