I have been stewing over a lingering question in my mind: Why have we seen a strengthening US Dollar in the face of QE Infinity?
The chart below is of the US Dollar Index, which is a basket 6 major currencies relative to the USD. The chart is low on the left to high on the right which signifies an uptrend.
I have come up with a number of reasons why we may be seeing US Dollar strength and a strong Dow and S&P:
Arguably China has a real-estate bubble. The country has been building the equivalent of 18 cities per year for the past number of years. As reported by 60 Minutes, these cities are ghost cities. The building has slowed down if not come to halt. Please reference this 60 minutes piece on the China Real-estate bubble. http://www.cbsnews.com/video/watch/?id=50142079n
The implications for the world economy in a halt in construction are:
Reduced demand for copper, steel and cement among other commodities. In addition as these projects are fueled on debt, China may face a credit bubble. Who supplies China with the commodities (copper, etc.) to build these cities? Mainly Australia, but Canadian miners are also affected; as a consequence we have seen the Canadian dollar and Australian dollar weakening over the past number of months. We can see this problem visually in the price of Copper, which has been declining for the past number of months. I believe as copper falls so will the Canadian and Australian dollars. I have included a chart of Copper at the bottom of this article.
If you are concerned about China slowing down, by default where do you invest?
The past couple of months we were reminded that the problems of Europe have not been solved with Cyprus facing banking failure. A bailout solution involved taxing (some would say stealing) 10% of the deposits held by deposit holders in Cypriot banks. If I were a European, I’d be scared to hold my hard earned euros in European banks. By default where do you go? Bit Coin?
Japan has faced 30 years of deflation, despite multiple rounds of quantitative easing. In an attempt to bring deflation to an end Prime Minister Shinzo Abe has introduced another round of QE. Immediate term consequences have been appreciation in the Nikkei and devaluation of the Yen. This has been a big contributor to the appreciation of the USD. I wonder if this round of money printing will solve Japan’s deflation woes for good, past rounds seemed ineffective; somehow I doubt it.
Interesting to note that Mark Cuban, an owner of an NBA basketball team, went all in on the Yen trade, see CNBC video: http://www.cnbc.com/id/100674739
Mark Cuban: “In December, early December, I went and took every penny of debt that I had with the Mavericks and personal debt and everything and converted it to a yen loan when I think it was in the mid-80s, and I've been really happy with it,” he said.
The implication for Mark is, so far, he has reduced his debt burden in USD terms by approximately 15% to 20%. Perhaps central planners from governments around the world should have taken Mark’s lead and converted their local debt into Yen debt as well!
If you are Japanese or not a billionaire foreigner seeking ways to lower you debt burden, by default how do you protect yourself from a devaluing Yen?
The US dollar remains the reserve currency of the world. Every day commodities like oil and natural gas are priced in US dollars. US dollars are needed every day to keep trade going around the world. This is why when equity markets rollover we see a bid under the US Dollar, because when risk is off – governments, business and individuals require US Dollars to pay bills.
Traditionally the US dollar and Commodities move inversely to one another. So as the value of the US dollar relative to the rest of the world currencies goes up, commodities like Gold, Silver and Oil will typically fall in price.
If you are a business involved in international trade, by default what currency do you use today?
The United States was first to the Quantitative Easing party. So for the first few rounds, QE lead to devaluation of the USD, but it has become evident that in order to stay competitive the rest of the world may be trying to catch up by implementing their own QE programs. Further rounds of QE in the US have become less and less effective at devaluing the US dollar. When it comes to QE maybe the US is First In, and First Out and the US dollar has received a bid as a result.
If you are an exporter in a country outside the United States, would you be more competitive if your local currency were weaker?
With falling commodity prices, perhaps central planners have been fighting disinflation or deflation and not inflation all this time.
If you are scared to invest in China and Europe and are fearful of the depreciating Yen, by default where do you invest? I believe the answer is the United States. I believe this is why we have seen US Dollar, S&P and Dow rise as they are the best horses in the glue factory.
And finally with the US dollar maintaining its reserve status the last lingering question is what happens if we begin to see the S&P, Dow and other equity markets correct? Bills will need to be paid, cash becomes king and I believe the US Dollar will receive a stronger bid as long as it maintains its reserve status.
When it comes to investing, you have options and I’d be happy to help you craft them. For a complimentary review of your portfolio or to open an account please give me a call or send me a note by email.
Edgar Burton, direct 416.479.8995, toll free 1.888.216.9779 ex. 402, email firstname.lastname@example.org
The chart below shows copper declining for the past couple of months: