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Analysis

The Year of the Dollar beckons

by Frederick Hopson, Advisory Board

The Year of the Dollar beckons

One feature of the New Year has been the turn-round of bets against the euro placed on the Chicago Mercantile Exchange. Traders abruptly covered their short positions or even went long of the previously so derided euro because Europe suddenly appeared to be solving its debt problems. How amazing! Greek or Irish bonds may well be restructured in some novel form, perhaps a swap similar to ‘old lamps for new’, based on an exchange of parity of the new Euro junk bond for 60 of the old Hellenic obligation. When this finally happens, might we perchance find out this doesn’t solve the currency problem?

It’s time for a reality check. The euro has merely retraced a small portion of its recent decline against the dollar, a decline that has been the subject of daily doom-mongering. Similarly another trend has surfaced on emerging market currencies. This is a theme that’s easy to sell and easy to justify. ‘They keep going up so it must be right….look how those guys are growing!’

Illustrious analysts and managers of gigantic bond funds tell us simultaneously that the US will soon be bust, Europe is going bust and Japan should already be bust. So shouldn’t their currencies all be worthless? Japan is the biggest relative debtor of speculative interest to currency traders, yet its currency stands at ¥82.70 to the dollar! That’s the level it traded at in 1995 after moving down from ¥260 in 1985. During the ‘lost’ decades it has gone from strength to strength, so something is wrong with the connection between foreign exchange rates and debt valuation. Cynical observers might conclude there may not be a connection!

What is sentiment really telling us about the dollar’s long- term trend? The last few years have been characterised by fundamental mistrust of the US currency owing to burgeoning American debt. But the view that is interrupted from time to time by terror attacks and coups in small and not-so-small countries, when the dollar suddenly becomes a safe haven. We’re seeing a little of this now over Egypt.

This safe haven feeling also exists for the hallowed Swiss franc, even though Switzerland is playfully described by one of my American friends as a toy country.

So the market continues to generate its own illusions and as we all know they change daily as thousands of clever people in the boiler rooms are paid large sums of money to keep the machine pounding away at maximum speed.

The current lack of fundamental regard for the dollar reminds me of a previous period when gold was high and everyone believed the dollar was washed up for good – at the end of 1979 when gold was on its way to a high of $850. This ushered in a five year dollar bull market and gold went out of fortune for 20 years.

Gold is now being rediscovered by central banks, who play their own game of ‘watch the press’ but unfortunately not ‘watch the markets’. Partly nostalgically, they are finally looking to buy gold again. The counter-cyclical investor would consider that unsettling, to say the least!

The Swiss franc is at absolute highs, the yen at multi-year highs, gold close to its high. Surely all this gives us cause to worry. Whenever anything seems that clear in the markets, we can generally expect to face a change. Hindsight tends to be painful. Think of Gordon Brown and the Treasury decision to sell British gold a decade ago.

A simple example of market blindness was the US property market. Once it had finally been repackaged so that it could never fail, we experienced the biggest decline in wealth of all time. Even the casino owners suffered for a while.

So let’s all take a deep breath and think. If the US economy really is recovering, perhaps the next argument will be that the US dollar is set to recover too! At least for a while, maybe a few years even. It is foolhardy to try and predict long term movements. But as long as gold is being pushed as the new currency of choice, it feels a lot safer to be long of the dollar.

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