Why Dollar Down, Stock Market Up ( WSJ opinion)

OPINION OCTOBER 7, 2009, 9:06 P.M. ET

The Weak-Dollar Threat to Prosperity

Measured in euros, U.S. per capita GDP is down 25% since 2000.
By DAVID MALPASS
If you want to know why the dollar has been falling this week and gold hit a new high, look no further than the weak jobs numbers last Friday and the weak communique issued over the weekend at the G-7 meeting in Istanbul. Deploring "excess volatility and disorderly movements in exchange rates" isn't exactly a ringing defense of the greenback. And 9.8% unemployment convinced markets that monetary policy will remain loose regardless of dollar weakness.

Bond buyer Bill Gross of the Pimco fund summed up the situation nicely in a recent CNBC interview. Asked whether low interest rates will weaken the dollar, the influential allocator of global capital said: "I think that's part of the administration's plan. It's obviously not announced—the 'strong dollar' is always the policy, so to speak. One of the ways a country gets out from under its debt burden is to devalue."

On the surface, the weak dollar may not look so bad, especially for Wall Street. Gold, oil, the euro and equities are all rising as much as the dollar declines. They stay even in value terms and create lots of trading volume. And high unemployment keeps the Fed on hold, so anyone with extra dollars or the connections to borrow dollars wins by buying nondollar assets.

Investors have been playing this weak-dollar trade for years, diverting more and more dollars into commodities, foreign currencies and foreign stock markets. This is the Third-World way of asset allocation.

Corporations play this game for bigger stakes, borrowing billions in dollars to expand their foreign businesses. As the pound slid in the 1950s and '60s and the British Empire crumbled, the corporations that prospered were the ones that borrowed pounds aggressively in order to expand abroad. Though British equities rose in pound terms, they generally underperformed gold and foreign equities. At the end of empire, the giant sucking sound was from British capital and jobs moving offshore as the pound sank.

Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs.
The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability.

If stocks double but the dollar loses half its value, who beyond Wall Street are the winners and losers? There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. Rich people got richer, seeing their equity bottom line double. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages.

Equity gains provide cold comfort when currencies crash. From the euro perspective, the S&P peaked at 1700 in 2000, finally reattained 1100 in the 2007 bubble, fell below 600 in March and now stands at 700 (see nearby chart). With most of the market capitalization of U.S. stocks held by Americans, the dollar devaluation has caused a massive decline in the U.S. share of global wealth.

Measured in euros (a more stable ruler than the ever-weakening dollar), U.S. real per capita GDP is down 25% since 2000, while Germany's is up 4% and tops ours.

The solution is a strong U.S. jobs and wealth program. It has to include stable money, a flatter, more competitive tax structure, spending restraint, and common-sense bank regulation so small business lending can restart. Treasury has to rapidly lengthen the maturity of the national debt and take steps to protect the Fed from market losses on its long-term debt holdings.


Instead, Washington's current economic program pushes capital away by weakening the dollar, threatening higher tax rates, borrowing short (the Fed's near trillion-dollar overnight debt, Treasury's mounds of bill and note issuance) to lend long (mortgages, student loans, entitlements), doubling down on government subsidies, and rechanneling bank loans to governments and big businesses instead of the small business job-growth engine.

It's possible global bond vigilantes will call Washington's bluff, reducing their bond purchases until we stop devaluing and restart job growth, which is the ultimate source of tax revenues to repay our bond debt. This would create a Volcker moment when the U.S. might tighten even as the economy slowed (as then Fed Chairman Paul Volcker did back in 1979).

But the accepted outlook is the almost-as-gloomy new norm. If all goes according to current plans, the dollar devalues slowly and bond buyers come back for more even as national debt heads toward $15 trillion. World living standards grow faster than ours, as does global wealth. The Fed chases inflation as the dollar sinks, but not so fast as to stop the recovery. More capital moves abroad, leaving U.S. unemployment too high too long.

A better approach would start with President Barack Obama rejecting the Bush administration's weak-dollar policy. This would invite capital and jobs to come back before interest rates have to rise.

Mr. Malpass is president of Encima Global LLC.

What to do about the Falling Dollar (Credit Suisse)

The Dollar Is the First Victim of the Recovery


Joy Bolli, Online Publications Credit Suisse


14.09.2009 Over the last few weeks, stock markets have been performing positively – optimism seems to be back. According to Giles Keating, Head of Credit Suisse Global Economics & Strategy Group, this optimism is based on real facts. However, what is good for the world economy doesn't look to be so good for the dollar.

Joy Bolli: Giles, what's behind all this good news?
Giles Keating: First of all, the economy is recovering more strongly than most people expected – albeit from a very low base: We still have lots of unused capacity and we still have high unemployment, but things are moving in the right direction. Secondly, there is a lot of cash out there. Many investors were left behind given the strength of the early pick-up in the stock market. Now they are wondering if they shouldn't be putting their money to work. And thirdly, the policy makers - central banks, governments - have signaled that they are going to maintain a very expansive economic policy, that they are going to keep interest rates very low for a long time, and that they are going to continue their fiscal spending.


What are the risks going forward?
Clearly, one risk is that this economic recovery won't continue, and some economists are very concerned that things might start to drop off when the current rather strong momentum is over in perhaps two or three months' time. The consensus in the Credit Suisse Economic and Strategy Group is, however, that this risk is not very high. On balance, we think that the recovery will continue, given the expansiveness in monetary and fiscal policies. Another risk is that we could actually see some markets moving ahead too strongly, for example some commodity prices. And that, of course, could create trouble elsewhere.


Does this mean that the next bubble is just around the corner?
I think there is a small risk that there's a bubble around the corner. It's more likely that the problem of a bubble lies perhaps 12 months, 24 months or maybe slightly longer into the future. We do know that the financial markets are very prone to lurch between crash and bubble. The very strong medicine that's currently being administered in terms of very low interest rates is great for getting us out of the slump. But history tells us that it does tend to lead us toward the next bubble. So I think there is a risk, but right now it is more likely that we will see prices tending to move up in a number of areas, though probably not reaching into bubble territory for quite some time.


Amid all this good news, the dollar seems to be in trouble. Just a temporary weakness, or a fundamental problem?
The dollar has seen some big downward movements over the last couple of weeks, and although we think that this won't continue in a straight line, we do think it likely that the dollar will continue to weaken over the next six to twelve months. This can be expected to happen both against the major currencies like the euro and the Swiss franc, as well as against some of the high yielders like the Australian dollar and even some of the emerging market currencies like the Brazilian real. So we are recommending diversification out of the dollar.


What makes the dollar so weak?
Interest rates are, of course, very low in the United States, at almost zero. Although they are low in other countries as well, historically the dollar has needed an interest rate premium - a higher interest rate - than in Europe in order to remain stable or rise in value. Another key reason is that, strangely, as financial conditions get less risky and become more stable, people tend to move out of the dollar. Moreover, a lot of people put money into the dollar during the crisis, and now they have too many dollars. And finally, financial transactions were made by some of the world's major banks at the end of last year since they had to buy dollars in order to square up their balance sheets. That effect is now more or less over. For some banks, this is actually going into reverse, so they are now selling dollars.


Do all investors share this rather pessimistic view of the dollar?
No, of course this is a controversial issue, and I know that many investors, although they recognize the dollar problem, also see problems with other major currencies like the euro. But we believe that there are many financial forces that will boost the euro against the dollar. We would therefore recommend a diversification strategy for those who don't feel entirely confident with the euro. In fact, we consider it a good idea for all investors to diversify broadly into a number of other currencies, as well as – to a lesser extent - into precious metals like gold.

Which industry will surprise us with good news in the next six months?
I think a number of them could, but one in particular that my colleagues and I at Credit Suisse would pick out is the technology sector. We have already begun to see parts of the tech sector move up from very low levels. And as we move forward, there are several very favorable factors here. It's not so much consumer demand, although that could play a bit of a role; rather, it's greater demand from companies that cut back their IT expenditure in a big way during the slump. This, along with some new technologies that are coming through, leads us to think that this sector could perform rather well.


And which commodities will be among the best performers?
We think precious metals can continue to move up. At this current time, gold for example has just broken through the 1000 dollar level, and we think it could certainly head to somewhere around the 1100 level. And some of the other precious metals like platinum could continue higher. We are slightly more cautious about base metals such as copper. We think their inventories have gotten somewhat too high. Regarding oil, some of the bigger countries in OPEC are not keen to see oil get too strong. So we think the trend is up, but perhaps not dramatically so.

the Declining Dollar - Hedge Your Portfolio (Barrons)

Foreign-Reserve Bingo
By ROBERT FLINT
What investors seek as they exit dollar-denominated assets.



INVESTORS OF ALL STRIPES NEED TO BRACE THEMSELVES for a world in which the U.S. dollar no longer plays the dominant role.Although the greenback will remain the currency of choice in trade and finance for many more years, signs have already emerged that changes are under way.

Governments abroad have grown increasingly skeptical about the dollar as a store of value for their national reserves. China, Russia and others have expressed concern about their dollar-denominated holdings because of the budget deficits the U.S. faces in financing bailout and stimulus measures.
Some countries have taken steps to reduce the proportion of their reserves held in dollar-denominated assets by switching to investments that will hold their value as consumer prices rise.
The U.S. decision announced Wednesday to boost sales of Treasury inflation-protected securities, or TIPS, is largely seen as a nod to China, the world's largest holder of U.S. government debt.


The search for alternatives to the greenback, while still in its early stages, will eventually have broad implications. Diversification of foreign-exchange reserves is no longer an issue solely for central banks and monetary authorities.

So where does that leave individual investors? Is there such a thing as a diversification play?

There is, say analysts, but it's more a long-term strategy. The dollar's allure has been tarnished, but any significant shift away from U.S. assets by central banks will take years.

"It won't happen overnight," says Andrew Busch, global foreign-exchange strategist at BMO Capital in Chicago.

There's still no other country or region that can match the liquidity and depth of U.S. capital markets. The dollar will continue to play a key role in the placement of foreign-exchange reserves until a viable alternative emerges. So far, there's been no evidence of any officially sanctioned dumping of the dollar.

One strategy for investors would be to mimic central banks and slowly move more of their holdings into non-dollar-denominated assets. The euro is most obvious option, at least in the short run, says Busch.

James Trippon, editor of the China Stock Digest, suggests investors can position themselves to benefit from inflation and a declining dollar through commodity-related plays in energy, metals or even foodstuffs. Australia and New Zealand, with commodity-based economies, stand to benefit as the world economy heals and growth speeds up again in China.
Another option would be American depositary receipts of Chinese corporations in the energy, banking or insurance sectors, Trippon says.

For private investors as well as central banks, it amounts to slow and careful diversification away from the dollar. Coping with a less-than-almighty dollar is an unnerving prospect for many Americans, but one they are bound to face.




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