Saturday, August 11, 2007

Dollar Dynamics


Question #1: Will the Dollar Ever Stop Falling?
My short answer is yes .
Believe it or not, the dollar has actually had two major bull market rallies since it began trading in competition with the other major currencies back in 1972. The buck has had two major bear market declines, and is now locked in its third bear market dating back to July 2002.
It was 1972 - a year that forever changed the currency world. Until then, all currencies were anchored against the U.S. dollar and countries holding dollars were allowed to exchange them for gold. (The system worked pretty well - because you consistently received real tangible wealth for paper money.)
President Nixon changed that by removing the dollar from the gold standard in 1972. In currency terms we say he "closed the gold window" when he realized gold was streaming out of Fort Knox faster than he liked. So 1972 was the year the major currencies began "floating" against one another, driven only by supply and demand. Now they all trade on a promise from central governments - no more gold.
The chart below shows the performance of the U.S. dollar index since 1972. As you can see, there have been several bull and bear markets just over the last 35 years. It's also important to note that the current bear market in the dollar has pushed it close to a fresh all-time low in the buck.


What Makes People Squirm about the Dollar
The dollar's troubles are driven by real long-term fundamental concerns that have a lot of people worried. The major concerns are:
U.S. Industrial and Technology Base Fading: Economic power in manufacturing and technology is shifting away from the U.S. to Asia. What a country produces and exports represents a country's real underlying asset-base. When that fades, it's definitely bad news for that country's currency.
Out of Control Spending: U.S. spending is out of control both domestically and internationally. Many believe the U.S. Treasury is being bankrupted with all this spending and increasing commitments around the globe to fund an empire.
U.S. Capital Markets Losing Their Luster: Strong capital markets support a currency by virtue of attracting capital for business. There's concern U.S. capital markets are losing their competitive luster, as more financial business shifts out of New York to London and Hong Kong.
U.S. Is Losing Friends Fast: Rightly or wrongly, the world is not happy with U.S. foreign policy. It seems we are making more enemies than friends in the world lately. This is negative for our currency as it leads many to consider all viable alternatives to holding U.S. dollars.
Those Who Control the Oil Control the Money: Energy trading around the world is based in dollars. In other words, if a country needs to buy oil, it must also hold U.S. dollars to buy it. Thus, global energy trading is a major support for the buck. But that could change. Energy resources are now controlled primarily by non-Western companies. Many are direct enemies of the United States. It's estimated they now control 60-70% of all known world's energy reserves. If these nations decided they no longer want to accept only U.S. dollars for their oil, it could be a very serious blow to the buck.
Question #2: What is the Best Single Long-Term Play in the Currency Markets?
Without a doubt, the Chinese yuan looks poised to appreciate most in the years to come.
China has been suppressing their currency for many years. They believe a weak currency is the key to driving and maintaining export growth. Export growth is critical for them as it creates jobs. And jobs are critical for the ruling elite in China because they are extremely concerned about the potential for social unrest.
But pressure is building for a change in China's currency policy. It will change, and when it does, this currency promises to soar. Eventually, the domestic consumer market will evolve in China, so Chinese will buy the cheap goods they create themselves (rather than importing them to the west).
When that happens, China will no longer have a need to suppress their currency, and the yuan should move dramatically higher to its true value.
Most economists believe the yuan is at least 40-60% undervalued against the dollar. I think it could be much more. Back in the late 80's, the Japanese yen and Japan were in a similar place as China now. Western nations forced the yen higher in value. And it soared around 80-90% in just a few years.
Plus, just in the past few days, China has threatened to use their estimated US$1.33 trillion in U.S. dollar reserves as a political weapon. They're threatening to dump their reserves and deal a deathblow to the U.S. dollar, to retaliate for any trade sanctions imposed by Congress. The fact that they're starting to use their reserves as a bargaining chip is just another bullish factor in favor of the yuan!
So from a long-term perspective, I believe owning yuan deposits for long-term capital gains should be a winner. You can buy yuan deposits through both domestic banks and offshore banks. But keep in mind, by owning a single currency you take on specific risk. But there is another way to play the Chinese currency appreciation, and diversify at the same time.
I expect once China allows its currency to appreciate more rapidly, other Asian-bloc nations will follow China's lead. That’s why I’ve devised a specific strategy that allows you to buy six of the world’s top-performing currencies (including the coveted Chinese currency) and gold for a relatively low minimum investment. I introduced this dynamite strategy to Sound Of Cannons members back in March, but it’s such a savvy currency strategy, that I have to make sure you hear about it too. Click here right now to read all about it.
So, will the dollar ever rally again? No doubt it will. The only question is: How much more does it fall in this bear market cycle? There's no way of telling. But either way, I think the real bang in currencies over the next few years will come from Asia.

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