Dollar Poised For A Dip
By Axel Merk
08 November, 2006
Asia Times OnlineMaking short-term predictions about the US dollar is notoriously difficult. So why do we say the dollar may fall after Tuesday's mid-term elections in the United States? Once we know what the future composition of Congress will be, the markets can shift focus from the excitement of the moment to what may lie ahead.
We believe we have just seen the beginning of a more pronounced slowdown that will likely push us into recession. The reason we are more negative than many economists is that high levels of
consumer debt make the economy much more interest-rate-sensitive than in past economic cycles.An area where this is particularly apparent is in the housing market, as consumers in the US, a so-called ownership society, have massive levels of debt accumulated in their homes. Given that only short-term interest rates have risen, only the most speculative homeowners with adjustable rate mortgages should have been affected.
But in a world where the speculators have driven up prices, the speculators are also dragging the entire market down with them as the housing bubble deflates. If and when long-term rates reflect that we may be heading into an inflationary or stagflationary environment, the fallout for the housing market could be severe, as higher long-term rates squeeze masses of homeowners who need to refinance their mortgages in the months and years ahead.
For now, market commentators try to grab on to every bit of good news released. The "best" news seems to come from corporations that are involved in the option-backdating scandals: these companies do not report their balance sheets while they investigate their wrongdoings. Wall Street loves them, as revenue is the only reliable number released - and US executives have become experts at generating top-line growth.
Indeed, in recent months, just about any piece of news has been interpreted as good news by the markets. Even in a perfect world, it is time to get very concerned about such exuberance. But the world is not perfect: when retail stores have same-store sales increases behind the rate of inflation, when hourly wages rise at a rate higher than economic growth, we have all the hallmarks of stagflation.
Remember those who were touting to buy stocks at the top of the dot-com bubble? Remember those who said there was nothing to fear from the housing market only this year? These are the same pundits who called the top of the commodity boom this summer. It turns out that while the US economy is slowing down, oil is about 50% higher than two years ago, gold is again above US$600 an ounce, and base metals hover once again near their highs.
Investors have been distracted from the big picture. And this is where the election may play a pivotal role. None of the challenges have gone away, but we now are faced with a US economy that may slide into recession. The best news about the new composition in Congress is likely to be that it will get less done, which means that politicians can spend less. But just as equity and bond markets have priced in perfection, investors have also given more confidence to the dollar than it may deserve. Then again, many investors are not aware of just how much the dollar has weakened.
If you have managed to avoid the fall in the dollar, your purchasing power will be much stronger now. This year, the dollar has resumed its downward trend that was interrupted in 2005. As long as the US economy focuses on growth rather than savings and investments, this trend may continue.
When we say the dollar may weaken after the election, we know as little as anyone what will happen to the dollar in the days that follow the election. But we believe that the focus will shift to what is ahead. Given that timing currency moves is extremely difficult, investors may want to consider taking a long-term approach by broadly diversifying into a basket of hard currencies, that is, those currencies backed by sound monetary policy.
Axel Merk is the portfolio manager of the Merk Hard Currency Fund, a no-load mutual fund that invests in a basket of hard currencies from countries with strong monetary policies assembled to protect against the depreciation of the US dollar relative to other currencies.
Copyright 2006 Axel Merk
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