VOLUME   1.12 1.
9 
The Dollar’s Descent:
Orderly or Not?
The global economy is operating in an untested
and entirely artificial environment.
Governments have intervened in every market
from bonds to mortgages; they have even
managed to keep Chrysler in business.
Subtracting the effects of stimulus, the real
underlying strength of the economy is a
mystery.
Near zero interest rates have fueled a
speculative bubble as the dollar has become the
carry-trade vehicle of choice. People are
borrowing to speculate on assets, not to spend
on production. American labor force figures do
not show any pick up, whether measured by
hours worked, unemployed and discouraged
workers (16%) or the trend of total
employment. The situation is unsustainable
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VOLUME 
OCTOBER 30, 2009 
and will, if it continues, become dangerously
unstable.
The next phase of this cycle will be
influenced by the global reaction to the U.S.
Administration’s attempt to reflate its way out
of the deep recession and export deflation to
other countries via dollar devaluation. Federal
Reserve monetary policy has effectively
become the global monetary policy. The
willingness of central banks in Asia and the
Middle East to prop up the dollar enables
excessive U.S. credit expansion, while
simultaneously transmitting the Fed’s policy
around the world. This was a fundamental
cause of the parade of bubbles that culminated
in the 2008-09 financial crisis and we are
heading down the same path again.
 
 Despite the Fed’s accumulation of over rates and Fed purchases of risky assets will

a trillion dollars of incremental assets, M2 gain traction.

money supply continues to remain weak and

business credit is still declining (Charts 1-3).

CHARTS 1-3
Money is freely flowing into commodities,

stocks of both emerging and developed

countries and foreign real estate, but not yet

into the real economy in any meaningful way.

What lift there is to GDP is entirely related to

government stimulus programs, not credit

expansion.

Peering behind the veil of stimulus

provides an ugly picture. Unemployment is

still rising and other labor market indicators

remain very weak. Subsidies to car and home

sales are providing only a temporary boost

which borrows from future demand. Mortgage

modification programs have suppressed a flood

of foreclosures. It is clear the U.S.

Administration is propping up the economy

with helter-skelter stimulus programs while

hoping that the magic of near zero interest

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 The operation could be time sensitive
as a quick economic rebound is needed to
contain fiscal deficits. A double dip recession
would be a disaster for the already terrible
fiscal outlook. The U.S. has had no problem
selling Treasuries so far, but if the recovery
proves temporary, investors may well revolt at
yet a further surge of government debt.
Therefore investors need to watch Treasury
bond yields closely.
Investors should also keep a close eye
on the U.S. dollar as this plays out, as it will
provide one of the clearest indications of
whether the recovery is derailing. If the dollar
breaks down significantly from current levels,
it would signal a loss of confidence in the
U.S.’s ability to finance the Fed’s buying
spree.
Despite the risks to the recovery in the
U.S. economy, and the untenable long term
fiscal outlook for the Treasury, our view is that
the U.S. dollar will continue a relatively
orderly decline. This trend originated when
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the 2001 tech-wreck reversed the flow of
capital that had previously been chasing the
American based technologies and media
mania.
The only major counter-trend move in
the dollar happened early this year, as capital
inflows pushed the dollar up by 15%. This
buying has since reversed, leading to a sharp
decline and bringing the dollar back within
about 5% of its pre-crisis levels (Chart 4). It is
worth noting that this decline has nothing to do
with a loss of confidence in the U.S. as some
have argued. If it had, Treasury bond yields
would not be stable. Rather it is a function of
the deployment of capital in emerging markets
and commodities, much of it financed with
cheap U.S. denominated loans.
Most indicators are pointing to a kind
of soft landing for the dollar in the short term –
a gradual petering out of the decline. This
would allow the U.S. to continue to export
deflation to countries whose currencies are
appreciating, helping the U.S. rekindle its
CHART 4 capital flows with a 2% tax on foreign

portfolio investment. China recently relaxed

capital restrictions to allow more outward

foreign investment by Chinese nationals.

Canada’s central bank has sent strong signals

that it will resist raising rates as exchange rate

appreciation is expected to “more than fully

manufacturing base and address global
offset” favorable economic developments since
imbalances. Those that are pegged to the
July. This talk alone knocked a few cents off
dollar, like China, are experiencing rapid asset
the loonie. International efforts will
inflation and economic resurgence. This is
increasingly provide a floor under the dollar,
good as long as it lasts and that could be for
implying that it will be hard to get the dollar
some time. There is no sign of domestic
down much from here, at least in the short run.
inflation in the United States. Consumer prices
Export and commodity based
are falling, TIPS/Treasury spreads are low and
economies are faced with a difficult situation
stable, and excess capacity abounds. The U.S.
as financial flows have driven a massive rally
has had no trouble holding down long rates, an
in stock and asset prices while export sectors
indication that the bond market isn’t worried
have been hobbled by rising currencies. For
yet.
example, so far this year, stock indices in
Countries experiencing upward
certain emerging markets have shown some
currency pressure against the dollar are
staggering gains relative to the developed
becoming increasingly concerned and willing
nations (Table 1). Note that the table does not
to intervene. Brazil is attempting to control
account for currency shifts, so the disparity

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between the U.S. and other markets is even them to tolerate currency appreciation to a

more dramatic. degree.

TABLE 1: EQUITY PERFORMANCE OF SELECTED Short term, almost everyone will be

GLOBAL MARKETS, YTD RETURN
forced to do what they can to keep downward
Industrialized Nations
United States % pressure on their currencies, namely
Dow Jones 30 Industrial Average 11.2
Standard & Poor's 500 Index 17.7 accumulating dollar reserve assets. Longer
NASDAQ Composite Index 30.6
Japan 13.7 term, this system is subject to a violent reversal
United Kingdom 14.6
Commodity Producers of capital flows, causing a stampede out of
Norway 53.6
Australia 25.9 developing countries that could flatten stock
Canada 23.0
Emerging Markets markets and real estate for a while.
Russia 124.9
Peru 112.9
There are several risks to our outlook
Turkey 87.6
China 86.9 for a gently declining dollar:
Indonesia 73.8
India 69.5
Brazil 61.8
1. There is an enormous amount of
Thailand 56.4
Singapore
speculation occurring in the financial system.
50.4

Commodities and emerging market equities

Only two countries have raised rates to have risen seemingly well beyond their

deal with overheating so far: Australia in early fundamental value. Any reversal in this

October, and Norway on Wednesday. Each money-fueled bull market could unleash

raised rates by 25 basis points, exacerbating another financial scare so long as the recovery

upward pressure on their currencies. Unlike is so fragile. Confidence in the ability of the

the export industry in most nations, neither is U.S. to mount another large scale bailout and

heavily dependant on U.S. markets, allowing stimulus package is far from guaranteed and

the dollar could fall victim. Although this

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scenario is a risk, we believe that is a relatively temporary phenomenon in the absence of a

low probability event for the foreseeable strong and sustainable recovery in the real

future. But clearly, the dollar must be watched economy. Until then, consumer price inflation

closely along with foreign central bank action (CPI) will not occur.

(as opposed to what they say). In our opinion, all of the above risk

2. It is possible that China may allow the scenarios are unlikely. However, they

Yuan to appreciate against the dollar by highlight that there is a great deal of

diversifying its reserves, particularly if asset uncertainty ahead. Policy makers are walking

price inflation continues to accelerate. There an impossibly thin line between frothy asset

has also been some talk about OPEC looking at markets and persistent deflation and

pricing oil in a basket of currencies, a rumor deleveraging. There is the clear risk that the

which OPEC predictably denied. Again, we authorities will either do too much too soon, or

believe this talk is unlikely to materialize into too little too late. But whatever they do, it is

concrete action for the foreseeable future. likely to be the wrong thing.

3. A major spike up in commodities, No one has experimented in peacetime

particularly energy and food, would be a major with global stimulus and credit creation on the

blow to the global recovery, scaring bond scale we have seen over the past year, and the

investors and consumers alike. However, we telltale signs of bubbles and emerging

still believe that deflation is the main problem imbalances are revealing themselves.

and that speculative or financial demand for The dollar reserve system is well past
commodities should not be confused with its expiry date, but there are no realistic
industrial demand. Speculative demand could alternatives for at least another 10-20 years.
well drive prices higher, but this would be a Pressure for change will continue to intensify

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as the Federal Reserve will continue with its have to keep in mind that there are plenty of

fire hose monetary policy to support domestic things that could go wrong quite quickly.

employment at the expense of international
credibility. A shift away from a dollar
dominated global economy over time will
undoubtedly bring great volatility, uncertainty
and new challenges in the transition.
Yields fell in the Treasury auction this
week, with the 10 year notes falling 17 basis
points over the week. We expect Treasury
yields to remain stable for at least the next few
months.

INVESTMENT CONCLUSIONS Corporate bonds continue to provide

The bull market in global stock markets good value, although spreads could begin to

and commodities remains intact. In particular, open up again next year if the economic

the U.S. has lagged far behind all other world recovery falters after the stimulus effect has

stock markets since the lows earlier this year. abated.

Some catch-up should be expected. However,
we do feel that it is time to start building
liquidity and take a more defensive posture.
Equity indexes in all markets are well above
their moving averages and vulnerable to a near
The gold story is very well known and,
at this point, it may be pretty well played out.
Any recent gains in gold have been due to the
CHART 5

term technical correction. Looking out 6-9

months, the possibility of another major down-

leg is increasing. Conservative investors

should begin to reduce exposure on market

strength. Aggressive investors may wish to

play the momentum for a while longer but they

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falling value of the U.S. dollar. Priced in

Euros or Canadian dollars, gold has been flat

for the past 6-7 months (Chart 5). Easy money,

very low carrying costs and fears of future

inflation could well keep the market frothy and

push prices somewhat higher. Pending a surge

in physical demand for gold, financial flows

into the metal could reverse swiftly.

In summary, asset price inflation and

rampant speculation are creating an

uncomfortable environment for long-term

value investors. Whether you are investing in

real estate in China, equities in Peru, or

indexing the S&P 500, you are putting your

faith in the ability of the U.S. Government to

pull off a miracle. Expectations will be tough

to meet, and the risk of the Administration

Tony & Rob Boeckh
losing a handle on the situation is a constant
October 30, 2009
threat. Over the next five years, investors BoeckhInvestmentLetter.com
info@bccl.ca
should focus on capital preservation and avoid
*All chart data from IHS/Global Insights and
getting swept up in the inevitable credit-fueled may not be reproduced without written
consent.
bubbles.

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STOCKS

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COMMODITIES

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CURRENCIES

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INTEREST RATES

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