TMFDeej (99.46)

Is the dollar really doomed?

May 19, 2009 – Comments (5) | RELATED TICKERS: UDN , UUP

Many people have been preaching about the imminent demise of the U.S. dollar lately.  It's not difficult to see why one would think that the dollar is doomed.  The United States has its printing presses running at full speed while the government is spending money like water and running up a record budget deficit. 

The White House has forecast that the budget deficit will hit $1.84 trillion this fiscal year, or approximately 12.9% percent of GDP.  I actually think that this estimate is on the low side and that we might end up being $2 trillion in the red by the end of the year and that it will be a much larger percentage of GDP (which I suspect will be lower than the optimistic folks in the White House are purporting to believe).

The United States is relying upon the kindness of strangers to finance this massive budget deficit.  Foreign countries, such as China and Japan which currently hold 23% of America's federal debt, will have to continue to purchase our bonds at the same pace that they have over the past several years, or even more rapidly for us to continue spending like we are.

The question is whether they will get sick of buying up all of our Treasuries and whether they will even be able to with economic problems of their own as a result of their exports falling at a record pace. 

Our "friends" in China and Japan have even been voicing their concerns about the U.S. dollar lately. 

-  Masaharu Nakagawa, the finance chief of the Democratic Party of Japan, said that he wants the United States to sell debt that's denominated in Yen.

-  Several months ago Luo Ping, head of China's banking commission was quoted as saying "We hate you guys. Once you start issuing $1 trillion-$2 trillion, we know the dollar is going to depreciate."

-  Even China's Premier Wen Jiabao said not that long ago that he is concerned about whether the "massive amount of capital" that his country has lent to the United States is safe.

So, the U.S. dollar is doomed right?

Not so fast my friends as the College GameDay's Lee Corso would say.

First of all, as the old saying goes, "In the land of the blind, the one-eyed man is king."  The exporting countries that relied upon the U.S. consumer for years are now starting to find out what things are like when the demand for all of their trinkets from the great consumers in the United States drops like a rock.  According to recently published statistics, Japan's industrial output has dropped by 34% and Chinese exports are off 23%.  As bad as things are in the United States right now, they're even worse in places like Japan and much of Europe.

Currencies are all relative, for a currency to fall off of a cliff it has to drop in value in relation to something else.  As long as the economies of other countries with major currencies, like the U.K., the European Union (I realize that this is not one country), Japan, and China are in rough shape their currencies will be under tremendous pressure as well.

Furthermore, the Chinese and Japanese currently hold a huge amount of U.S. debt.  If they were to stop buying our paper cold turkey, the value of their holdings would likely collapse.  They can rattle their sabers all they want, but if they were to make a major move they could hurt themselves as well. 

Check out the following quotes from an excellent article on this subject by Ambrose Evans-Pritchard"

Ray Maurer, from Qatar's QNB Capital, said China may be too busy closing factories it should never have built to challenge US primacy over coming years.

"China is not going to be a juggernaut until it creates a viable economy based on home consumption. It's just a tiger, living a myth," he said.

and

Lombard's Charles Dumas says the "super-savers" (China, Japan, Germany) have warped their own economies by relying on exports and, therefore, on perpetual debt build-up by the West.

"Their currencies are due to decline against the dollar as weak US recovery throws a few scraps from its table, over which the world's exporters will have to scrabble, cutting their prices and currencies in the process. The US is not, and is not about to become, Argentina or Zimbabwe," he said.

Having said all of this, I personally believe that the U.S. dollar will definitely lose value over time.  I am of the opinion that its decline will be more gradual than many others currently believe.  No one knows for certain what will happen.  As a result, I'm playing both sides of this game, inflation and deflation.  I have picked up stakes in a number of high quality companies in sectors like consumer staples as well as a large number of high-yielding corporate bonds that should be fine even in a deflationary environment. 

At the other end of the spectrum, I own stock in inflation hedges, specifically commodities like oil and natural gas.  Approximately 10% of my portfolio is in oil-related common stock and another portion is in preferred stock / bonds of natural gas companies.

The inflation versus deflation debate is a very interesting one.  As I have said in the past to me deflation is definitely the more immediate risk...unless the value of the dollar falls off of a cliff.

Asia will author its own destruction if it triggers a cri......

Deej