The Superdollar is King of Forex

I AM convinced that the world is on the brink of a secular dollar uptrend, a process that began with the death rattle of Lehman Brothers last summer.

By Matein Khalid (Money Maze)

Published: Tue 24 Feb 2009, 1:00 AM

Last updated: Thu 2 Apr 2015, 3:56 AM

This was the reason I warned about a collapse in crude oil prices to $25-30 last summer, when spot prices were above $130 in June and Goldman Sachs predicted a super spike to $200. This was the reason I concluded that Gulf real estate was wildly overpriced last summer and recommended shorts on Sensex at 17,000 and sterling at 1.80.

The superdollar theory is derived from my intuition and experience trading the global financial markets, from my intellectual debt to the theories of credit cycles and herd behavior postulated by Fredrich von Hayek, Ludwig von Mises of the Austrian School. My idol and maestro in the markets is George Soros, whose billion dollar killing against the British pound on September 15 1992 taught me that a central bank in denial means big money can be made betting against the self serving lies of governments.

I was a student at Penn/Wharton when Jim Baker engineered the collapse of the uber strong Reagan dollar at the Plaza Accords in New York. The subsequent three years were a license to print money as the German mark, Swiss franc and the Japanese yen soared in value. The early 1990’s banking crisis and the invasion of Kuwait were also the golden age of the dollar bears. The Clinton dollar, however, began to rise as the New Economy/Silicon Valley attracted the world’s imagination and capita until the inevitable dotcom meltdown, 9/11, Enron/WorldCom scandals and the 2001 recession. Then George Bush and Alan Greenspan engineered an epic six year devaluation of the dollar that abruptly ended with the Wall Street credit crunch in July 2008. History went fast forward last summer, things fell apart, the centre did not hold, the Euro lacked all conviction and the dollar bulls went on a rampage. Why?

One, hedge funds slapped with a trillion dollar margin call were forced to liquidate assets worldwide and repatriate capital to meet redemption notices from panic stricken investors. This was coupled with the unwinding of the Japanese yen carry trade and an exodus of funds from emerging markets by US pension funds. The fear trade meant the yen and the dollar were classic safe havens.

Two, as US imports and oil prices collapsed, so has the American trade deficit. It could well fall to $300 billion next year, half its level only a year ago. This is a seismic shift in the equations of international finance whose impact on the FX market will be immediate and brutal, a global supply squeeze of dollars.

Three, the ECB has mismanaged monetary policy in the Eurozone. The Maastricht Treaty does not permit the Germans to bail out their historic cronies in Hungary, the Baltics or the Balkans. Meanwhile, Spain, Ireland, Greece, Portugal and Italy all face debt shocks, as the spike in their government bond spreads over German Bunds suggest. Meanwhile, the ECB has no lender of the last resort role nor political mandate to determine fiscal policy responses to the European credit crunch. The looming sovereign debt disaster in Eastern Europe’s bankrupt economies are also a sword of Damocles for the Eurozone and the ECB. Chicago’s Milton Friedman predicted the Euro would never survive its first deep recession. I doubt if the credit crunch will kill the Euro but it has definitely devalued its role as a global reserve currency, the proverbial anti-dollar.

Four, the Japanese yen is no longer the dollar’s safe haven peer as the unwinding of the carry trade is almost complete. The strong yen has devastated Japan’s export economy and the rock bottom credibility of the LDP and Prime Minister Taro Aso. The resignation of Nakagawa – san after the fiasco at the G-7 in Rome (sake and jet lag are a lethal combination!) is a grave risk to the government budget.

Foreign exchange markets illustrate the logic of John Maynard Keynes’s fabled “paradox of thrift”. In a deflation world where central banks slash interest rates to zero, those governments who eschew quant easing (printing money so rates fall to zero) will attract negative carry trade hot money. This means speculators will sell their currency because they believe their central banks are out of touch with reality and their economics are going down the tube. This was the fate of Britain last summer as Mervyn King, an obdurate Cambridge don turned central banker who mismanaged the run on Northern Roc, stubbornly refused to slash the base rate in 2008 even while RBS, HBOS and Lloyds faced near fatal bankruns. Professor Blanchower, the sole voice of dissent on the MPC, blamed King “for fiddling while Rome burnt”, as sterling fell victim to the wolf packs in the currency bazaar. The same fate has befallen the Euro as the Bundesbanker inflation fighters on the ECB remain fixated on their Weimar Republic obsessions.

It also seems as if interest rate differentials have become irrelevant to FX rates, as they are so miniscule, a revolutionary paradigm shift in the currency markets. The erratic policies of Bernanke and Paulson (the Bear Stearns shotgun marriage to J.P. Morgan, the decision to let Lehman Brothers fail, the Fannie, Freddie, Indymac and AIG takeover, the TARP flip flops) have also injected a “fear premium” in the financial markets, as the spike in the volatility curve proves.

There is simply no hope of any return to investor confidence as money center bank shares get wiped out with the US Treasury a silent spectator, when the economy shed 500,000 jobs a month, when the Republicans in Congress sabotage Obama’s admittedly Democratic politically padded fiscal stimulus. This is the reason I expect Superdollar to be king in the digital global money souk. If America cannot lead the world from the abyss of deflation, who can carry the baton? Inflation, trillion dollar budget deficits and a dollar collapse make no sense when the non borrowed reserves in the banking system, when the money multiplier and thus the velocity of money in circulation has plunged, when the bond market has died. Obamanomics policy chickens will come home to roost in 2012 inflation shocks. Right now, Obamanomics is no deterrent to the superdollar.

I have argued the bullish case for gold in successive columns since November, as prices were in the $740 range with a target price of $1200. The rise in the price of gold above $1000 an ounce vindicates my view that Lord Keynes’s barbaric relic with which Lenin wanted to pave the floors of capitalist bathrooms is a hedge against both the current debt deflation death spiral as well as an insurance policy against the tsunami of Treasury debt issuance implicit in Obama’s trillion dollar budget deficits. It is ironic that in their eagerness to bailout banking systems and reopen the frozen interbank money markets, the Western world’s leading governments have sacrificed their AAA credit ratings, as sovereign CDS spreads gone ballistic suggest.

The risk of a failed US Treasury or British gilt government bond auction has never been higher. This inexorable rise in sovereign credit risk contributes to the $300 Armageddon premium in gold prices, enables it to decouple from crude oil, commodities or even the higher dollar. In any case, as emerging markets currencies from the Russian rouble to the Indian rupee, the South African rand to the Indonesian rupiah and Korean won collapse against the dollar in a ghastly replay of 1998, gold surges in price against all major paper currencies.

It is no coincidence that the holdings in the SPDR gold ETF, the largest bullion backed index fund in the world are now above 1,000 tonnes. Yet while gold is the flavour de jour of the markets, I never allow myself to forget that real interest rates rise, not fall, in times of deflation. This means the risk of a catastrophic gold sell off cannot be discounted, particularly if financial markets stage a bear rally. It is prudent to be introspective even while chasing the yellow metal in boogie bubbleland.

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