The Decline of the Dollar

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The Decline of the Dollar: Four Torpedoes Headed Straight For the U.S. Dollar… Take Cover and Profit

by Frank Trotter, Special to Investment U
Tuesday, April 4, 2006: Issue #523

Editor’s Note: As you know, I’m currently in China exploring its heavily talked-about investment opportunities (there will be much to report when I return). But at home, there is a constant stream of discussion about the future of the U.S. dollar. I’ve asked one of the best in the business to discuss its fate – a friend and a longtime currency and metals specialist, Frank Trotter.For as long as “money” has been in existence, there has been debate about its value. At one time, the questions were simple: Is the coin you offer gold (or silver, copper, nickel, etc.)? How much does it weigh?

From about 1280 until today, the “Trial of the Pyx” has been held in London to maintain confidence in the money of the realm. Test coins are stored in a locked box (the “Pyx”) and the multiple keys required to open this box are distributed to unrelated parties. At least once a year these parties gather to open the Pyx and test the coins. If validated, the Trial Court certifies that public and private holders should have confidence in the coins of the Mint.

Today, we freely exchange money that’s not backed by gold or anything else with intrinsic value. The dollar is merely “legal tender for all debts, public and private.” And the fact is, its future is grim.

There are four major concerns agitating the dollar’s current value and jeopardizing its future. Let’s look at each of them and see what you can do now to brace your investment portfolio for a potential decline of the dollar. There’s even a way to profit if the dollar slides

The Trial of the Pyx for the U.S. Dollar

While we feel that the U.S. dollar is in a long-term downward trend, since 2002 we have felt especially that it was overvalued. And over the past four years it’s declined against most major currencies.

Today, in our own Trial of the Pyx, we have called in various “key-holders” to assess where the U.S. dollar stands. And here’s what they’re telling us

Key-Holder 1: The Federal Budget Deficit

The U.S. is running a budget shortfall over 4% of GDP. And when it runs a deficit it needs to borrow money. You already know that foreign creditors have stepped up to the plate to buy U.S. Treasuries – and foreign holding now stands at over 54% of net outstanding federal debt (in 1985 this was around 15%). But at the margin it appears that foreigners have purchased about 97% of net new U.S. debt issued over the past four years!

The Federal Reserve conservatively calculates that this has lowered long-term U.S. rates by 1.5%, and many think much more. Additionally, the World Bank estimates that nearly 70% of global foreign reserves are in U.S. dollars.

Imagine for a minute that one of two things might happen:

Foreign investors reduce the number of U.S. Treasuries that they buyor,
Foreign investors actually sell some of the Treasuries that they hold.

Our simple math leads us to conclude that rates will rise – perhaps abruptly, or the value of the U.S. dollar will fall, or both. What’s your bet?

Key-Holder 2: The Trade Balance

Hard on the heels of the Budget Deficit is what used to be referred to as the Trade Balance. Today, this is simply known as the Trade Deficit since it is nearly 7% of GDP and forecast to head much higher. Exports have been growing nicely, averaging 9% over the past three years as the impact of the lower U.S. dollar and global economic growth are felt. Unfortunately, imports have grown at a 12% rate and started from a higher nominal level.

The companion to the Trade Deficit is the Current Account Deficit, which also has to be financed for the books to balance. This figure explicitly requires investment from abroad, which has to come and at an ever-accelerating rate. With the drum beat of over $60 billion in net monthly financing, rates must rise or the U.S. dollar must fall to maintain foreign buyer interest.

Key-Holder 3: The Mortgage Market

Much has been written about the spending habits of the U.S. population. Collectively, we seem to feel that the good times have no end, that history no longer matters, and that housing prices will run upward forever. It is often noted that the savings rate in the U.S. has actually turned negative for the first time since the Great Depression.

One key companion to these well-researched topics is the growth in mortgage debt over the past four years. We already know that due to the artificially low rates of the Greenspan Fed refinancing of mortgages placed billions of dollars in the pockets of U.S. consumers. The data seem to show that much of this benefit was squandered on consumer spending, which does help to bolster the economy. But it has also severely expanded the demand for foreign goods. In addition, recent statistics suggest that as rates have climbed, spending is starting to drop.

But if the U.S. population was only refinancing, then the mortgage debt outstanding would stand level. In fact, over a period of time where there was net negative job growth and net negative increases in real personal income, mortgage debt outstanding has grown at an average rate of 12.41% over the past four years – around four times the current growth rate in GDP! But perhaps more important to this discussion, you may not realize that the mortgage debt outstanding dwarfs U.S. Treasury issues (yes, mortgages are that taller bar in the chart below).

In and of itself, that is unremarkable – private markets are likely to be larger than their government counterpart…

Enter our foreign creditors again. While they do not yet dominate the mortgage market as much as with government debt, there are signs that the influence is becoming strong.

IndyMac, a major mortgage bank was quoted in The Wall Street Journal in August 2005 as saying that between 10% and 20% of their sales were directly to foreigners, and how many more are bought on the secondary market? In addition, The Wall Street Journal also reports that China has made direct purchases of mortgages through an agency – here we go again. To put this in perspective: If 20% of the new growth in mortgages were purchased by foreigners in 2005, that volume of purchases would amount to about 100% of the net growth in the U.S. Federal debt that year.

Key-Holder 4: The Wild Cards

Taiwan
Iran
North Korea
Nigeria
Terror

How You Can Profit From A Decline In the U.S. Dollar

The Key-Holders have spoken, and in all cases there is a significant risk for U.S. dollar decline. Doug Casey is fond of saying that the U.S. dollar is headed for its intrinsic value. While we are in agreement in the long run, for the foreseeable future we simply believe that the long-term prospects for the U.S. dollar are down.

Investors should look at ways to hedge against the potential decline by considering holdings of foreign currencies and precious metals in their portfolio.

For currencies, successful investors have maintained a core holding of euros, yen, New Zealand and/or Australian and/or Canadian dollars, changing the weighting for each group through time and adding in special situations. Right now, we favor the Canadian dollar and the Australian dollar for higher impact.

Metals investors are buying gold and silver to hedge against market disrupting risk from global crisis, from the long-term impact of inflation on purchasing power, and to profit from changes in supply and demand patterns.

Preparing for hard times in the U.S. dollar is one of the smartest strategic moves you can make in your portfolio right now before the debate over its “value” takes yet another negative turn.

All the best,

Frank Trotter

** The publisher of the Investment U e-Letter has a marketing relationship with EverBank, and Investment U, in addition to regarding the WorldCurrency Deposit Accounts and CDs as valuable investment tools, recognizes a responsibility and obligation to inform our readers of this relationship.

Today’s Investment U Cribsheet

I’d like to point out that investors utilizing EverBank’s World Currency deposit accounts since 2002 have been able to hedge against the U.S. dollar’s fall in purchasing power and profit from an increase in many of the major currencies across the globe. Without adding in interest income, euro depositors have gained 34%, Canadian dollar investors are up 37%, and the New Zealand dollar is up 53% after rising as high as 78%, from January 2002 through March 2006. In addition, we have observed many investors utilizing our no-fee Metals Select Pooled accounts, and especially see a bias toward silver for short-term prospects. For more information, please contact EverBank at 888.882.3837, or visit the EverBank website. **