Some sage gold watchers are expecting a major dollar devaluation before the end of the year!  Some say it could happen any day now.  Certainly, the fundamentals have pointed that way.  As we have discussed for some time now, this despite the repeated “Strong Dollar Policy” statements from the current and the last U.S. administrations. 

The concept is no doubt alarming and implies a radical change in global economics. We believe that should such an event occur it should be seen as a culmination of major changes precipitated by the ‘credit crunch,’ the rise of China and the imperative need for a change in the currency world to accommodate these events.  If such a change is not made, the currency world will see major structural fractures that will hurt the stability of the global economy, dramatically.

As you have seen from our work on this subject over the last few months and will see as this picture forms, major changes are inevitable. The question is, will they come about through a civilized adjustment or will confrontation and unilateral moves be needed?

Caveat

We issue a warning in the event this should happen. The entire currency world will be thrown off balance by such a move and every currency on this planet will feel the reverberations of such a devaluation and will for some time to come. If it happens in a civilized manner, it will still happen ‘overnight’ and catch us all by surprise.  If confrontation is involved, add fear and trepidation to that surprise. 

Interrelationships of Currencies

Global currencies are not independent of each other.  Yes, each currency is run independently and reflects the overall state of each country’s the Balance of Payments. Despite G-8 assurances that ‘competitive devaluations’ will not be undertaken by those bodies, the bulk of global currencies ‘encourage’ their exchange rates to retain global competitiveness through the adjustment of interest rates and more directly, occasional buying and selling currency in the foreign exchanges. Switzerland, Canada and Japan are good examples of this. Some nations, such as China, control the flow of funds through the exchange rate with capital controls, too.  Global trade is the cement that binds currencies together, allowing capital flows to adjust many Balance of Payments.  So, if the globe’s major reserve currency is devalued, no one will escape the impact on their daily lives.

For example, if the dollar is devalued against the euro by 30%, an Airbus will be that much more expensive than its Boeing equivalent.  An import from China (the yuan is pegged to the dollar) will also drop in foreign currency prices by 30%, but remain the same in the U.S. dollar.

Unless other nations retaliate by devaluing their currencies a similar amount, they will find their Balance of Payments skewed as though they revalued their currency by that amount against the U.S. dollar.

Alternative Currency or Stay With the U.S. Dollar?

So what should a local investor do?  If you believe it will happen, the obvious move is to get out of the dollar before it happens.  Of course, it is quite a gamble to stay in the dollar while the threat persists.  At what point is prudence gambling?

Many people have not thought through the Chinese rhetoric of the last few months as they spoke of a “Basket of Currencies” being the shape of their reserves ($2 trillion amassed to date).  This implies that China will accumulate the currencies of the nations with whom they trade and stop using the U.S. dollar as the intermediary currency for their global trade.  Currently, if you ask the price of a product from a Chinese exporter, you will receive a U.S. dollar price.  But systems are being practiced now to price both in the yuan and in the currency of the importer.  (This does not imply that the Chinese will sell the dollar.)

These changes are already bringing tremendous uncertainty to the global economy as we have seen economic conditions flow feely from one country to another through the banking systems.  So, where do you go?  Some investors felt there was safety with a respected currency such as the Swiss franc, until the Swiss government dropped their interest rate and sold Swiss francs into the market. 

This dropped the exchange rate of the ‘Swissy’ sufficiently to squash the thought that it would prove a haven from a falling USD/EUR.  Likewise, for a generation, the yen has been adjusted to the U.S. dollar with capital moving out when the yen was strong and exports leaving the country when the yen was weak.  So, is there a currency that one can rely on to preserve wealth?  Not one that will ride through all storms!  All currencies will see a buckling or a burgeoning at some point in time, demanding that prudence make us traders in currencies.


This is an excerpt from Aug 2009 issue of Trader's Journal.