The dollar's latest rally is over.
With global economic data showing signs of slowdown, the Federal Reserve is ever-so-close to moving toward a third round of quantitative easing, a program where it acquires long-term securities with newly created money. Fed Chairman Ben Bernanke recently hinted that the central bank could take further action, and if history is any indication, his comments could be the first step toward a slide in the dollar.
The Fed has already completed two rounds of QE, the first launched in late 2008 and the second in late 2010. Both times, a downward pattern emerged for the dollar. Using the new Wall Street Journal Dollar Index to get a broad measure of the dollar's value, expect the 22-month high in the index hit earlier this week to be the peak.
As a guide, here's how the dollar moved in 2010 leading up to and just after the Fed's second round of quantitative easing:
--The dollar hits a 15-month high in June 2010. The WSJ Dollar Index peaks at 78.882 on June 6, 2010. The dollar's big rally comes on the heels of new fears about a brewing debt crisis in Europe.
--The index falls through early August before climbing again in mid- to late August.
--The WSJ Dollar Index's August 2010 peak comes on Aug. 24, just a couple of days before the Federal Reserve's annual Economic Policy Symposium in Jackson Hole, Wyo.
--Mr. Bernanke says the Fed is considering a second round of bond purchases among other options to bolster the economy during a speech at the symposium. The dollar trades erratically for a couple of days before settling into a steady decline in anticipation of the program, which will add to the supply of greenbacks in the market.
--The Fed formally announces plans for "QE2" on Nov. 3.
--The WSJ Dollar Index bottoms Nov. 4 at 67.546, a 14% drop from the 15-month high hit in June and down 9% from the August high just before the Jackson Hole summit.
After taking steps earlier in the year to shield themselves from European banks and the collapsing Greek economy, some companies are using the summer months to fine-tune their approach to dealing with future volatility.
One strategy has been to sweep cash out of euros nightly and into other currencies to reduce foreign-exchange exposure, while others are looking at alternative payments in case customers flee the euro or run out of cash. Still more are trying to put in early-warning systems to identify risk.
Drug maker GlaxoSmithKline PLC and a handful of other big European companies have been sweeping cash raised during the day out of euros nightly to hedge risks of overnight devaluation. But even companies farther away from the center of the euro zone are plotting out moves for a potential crisis.
At Santa-Clara, Calif.-based laboratory testing-services company Evans Analytical Group LLC, CFO Christine Russell has been preparing a version of the company’s pricing list in pounds, betting that the British currency would be stabler than other currencies during a European crisis.
“We believe that our customers—especially our European customers—are just as willing to pay in pounds and may have more access to British pounds than dollars,” Ms. Russell said. EAG, which runs much of its European business out of France, began looking at the possibility a few months ago when concerns about the Spanish economy escalated, she said.
Because the company doesn’t run its finance operations out of the U.K., she said it would have to change its internal billing structure to handle payments in pounds. Ms. Russell said she has spoken with banks that could process transactions in pounds and checked how the company’s French bank might process overnight funds and exchange rates if EAG needed it.
FEW businesses do well in a climate of global political instability and mistrust of banks. De La Rue, the world’s largest commercial banknote printer, is one of them. The Basingstoke-based firm’s profits rose by a fifth in 2003 thanks in part to a contract to supply a new currency to Iraq. It also created a currency for the world’s newest country, South Sudan, in time for its independence a year ago. Disintegration of the euro zone would be terrible for most businesses but an opportunity for De La Rue.
Indeed, the financial crisis has broadly been good for banknote printers. The collapse of Lehman Brothers in 2008 led to a surge in demand for the folding stuff, which has not ebbed. Low interest rates have cut the opportunity cost of holding cash. With banks looking wobbly, many prefer to keep their money stuffed in the mattress, creating extra demand for banknotes. After falling steadily during the 1970s and 1980s, as the use of chequebooks and credit cards spread, cash in circulation has been rising again (see chart).
Private-sector printers like De La Rue inhabit a small but vital corner of a huge business. State-owned print works make around 85% of the 150 billion banknotes produced each year. But commercial outfits can be asked to step in when central banks fret that state printers may not be able to meet demand, as De La Rue did for the European Central Bank in 2001. Small countries are more likely to contract out banknote supply to commercial printers, who can harness economies of scale. That logic prompted the Bank of England to outsource its printing to De La Rue in 2003.
The firm devises 100 or so new banknotes each year as well as around 2,000 “design concepts”—a security feature, say, or a new image for a big-denomination bill. It has helped produce more than 150 currencies and won design awards for the banknotes it crafted for the central banks of Kazakhstan and Uganda, among others. De La Rue also prints identity documents, including British passports.
What do living standards look like measured in gold?
This is something I've been mentioning a lot recently.
The chart below shows the US government's own statistics on the median male full-time income in the US:
I use this because it compensates for a lot of things that have been going on, such as increasing female participation in the workforce, changing demographics or family size, or greater/lesser part-time work. These are "real" statistics, which means that it has been adjusted by the government's version of price statistics – which have been buffed and polished to look as good as possible. If the price statistics showed an additional 1% of price rises per year, over forty years, this chart would look a lot worse.
The interesting thing here is how there is such a definite inflection point, right where we go from a gold standard system to a floating currency system. A lot of other things have happened over that time, but we don't see any other major inflection points. You might think that the 1990s were really good for people, and the 2000-present era has been not so good, but oddly enough, there's no particular difference you can see on this graph (although maybe the government is monkeying the statistics more aggressively in 2000-present to make it look that way).
This is one reason why I think that the transition to funny money in 1971 is probably the most important long-term event for middle-class prosperity in the United States.
Hedge fund manager says yellow metal should be an integral part of investor portfolios
Global capital markets specialist and best-selling author James Rickards says that the ongoing currency wars are a combination of deflationary and inflationary factors that could leave painful scars on the global economy.
The New York-based hedge fund manager and author of Currency Wars: The Making of the Next Global Crisis says that the US dollar may no longer be the force it was in the past. Rather there will be a general swing in the financial system toward the gold standard, he says.
"Gold is not a commodity. Gold is not an investment. Gold is money par excellence," Rickards says.
The veteran fund manager says his target price of $7,000 (5,560 euros) for an ounce of gold makes even the most ardent of gold trumpeters seem conservative.
Rickards says during the currency wars, the global economies often engage in frequent devaluations of their currencies against the currencies of their trading partners in an effort to steal growth from those trading partners.
With both inflationary and deflationary factors at play, it is natural for investors to seek a safe haven for their investments. This, in turn, has pushed up the prices of gold, the historic hedge against inflation.
Gold prices reached a high of $1,600 an ounce in June, more than double the level in 2008. The price of the precious metal had dropped by about 15 percent from a record of $1,921 an ounce set in September, partly due to a stronger dollar.
The current currency war is the third such in recent times, and is more a combination of the deflation caused by the global financial crisis and the inflation from the US Federal Reserve printing more money.
Currency War I (1921-36) was dominated by deflation and ended in World War II, he says. However, Currency War II (1967-87), dominated by inflation, had a more "soft landing".
Rickards says that inflation in most of the emerging economies, including China, is a direct consequence of the Federal Reserve's decision to prop up the greenback by printing more money.
China has been facing an uphill task to keep inflation under control. Last year, the consumer price index, a major measure of inflation, averaged a high of 5.4 percent. In May this year the indicator dropped to a 23-month low of 3 percent after repeated tightening. But the Chinese economy has also been scarred by monetary austerity, leading to a three-year low GDP growth of 8.1 percent during the first quarter.
To prevent the dollar system from falling apart, the US needs to adopt a series of policies, including breaking up big banks, raising interest rates and cutting government spending.
"But it's highly unlikely that these policies will be implemented. So a dollar system collapse must be considered," he says.
Rickards says that going back to the gold standard will help people regain confidence in the currency because they will know they can convert their paper money to gold at any time and the government will make payment and this will keep the system honest.
Even if the dollar system collapses, the US will still be a superpower in the global financial system, he says, as it holds a substantial amount of gold reserves. Washington is believed to have gold reserves of more than 8,000 tons.
China, however, is at disadvantage in the gold standard system, as its reserves are still small, Rickards says. Only 1.8 percent of China's foreign reserves are in gold. With a population of 1.34 billion, the country holds just about $40.46 worth of gold per person. The nation last made its gold reserves known more than two years ago, and estimated them at 1,054 tons.
But China has also been steadily increasing its holdings. Gold imports through Hong Kong were 135,529 kilograms during the first three months of the year compared with 19,729 kilograms a year earlier, according to data provided by the Census and Statistics Department of the Hong Kong Special Administrative Region.
The ideal portfolio, Rickards says, should comprise 20 percent gold and silver holdings, 30 percent land, 20 percent fine art and 30 percent cash. He says he likes to stay liquid because cash gives investors "short-term wealth preservation" and the option to change into other assets.
Rickards says that both China and the US are enemies in the "Currency War III". Many believe that China has an edge over the US as it holds more than $2 trillion of US dollar-denominated debt. "Some even argue that China can dump the debt and destabilize the dollar. But I don't think it will happen.
"In fact, the US has the upper hand in this case as it can freeze Chinese accounts in the face of any attempted dumping and also substantially devalue the dollar," he says.
"China has been slow to realize this fact. In hindsight, their greatest blunder will turn out to be the trusting of the US to maintain the value of its currency."
China will never dump dollar assets, he says, but will slowly shorten the maturity structure and diversify its portfolio to include the euro, the yen and gold, as well as making direct investment in hard assets like mines and railroads.
In fact, China has been actively moving away from the US dollar in recent years. Besides buying more gold, China is also increasing position in other major currencies, including the Japanese yen. The percentage of dollar holdings in China's foreign-exchange reserves fell to a decade low of 54 percent in the year that ended June 30 last year, from 65 percent in 2010, according to data provided by the US Treasury. China is also launching direct trading between the yuan and other foreign currencies, as part of its efforts to depeg the yuan from the dollar.
"China will diversify away from the dollar in a much faster tempo in the future," he says.
As far as China's economic growth is concerned, Rickards says that he remains bearish, and anticipates China's GDP growth to slow to 4 to 5 percent over the next 10 years, which will in turn hammer the world economy.
Chinese economic growth has slowed this year and the government has lowered the country's growth target to 7.5 percent. It is the first time that the government has set a target under 8 percent, which was deemed as a must to provide sufficient employment.
"Everybody knows China needs to transform into a consumption-driven economy, but it is hard to achieve that goal," he says.
In Rickard's view, the private sector, instead of the State, should spearhead China's investment drive, as it is more efficient.
"Massive investments on infrastructure, which led China's growth in the past, can no longer be sustained and the country has to figure out a new way to keep growing."