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Dollar Downer
New York: October 12, 2009
By John Stephenson

At the height of the financial crisis, scared investors flocked to the U.S. dollar—a perceived safe haven investment. But today, the tables have turned and with a recovery starting to take shape, investors have been dumping dollars and piling into riskier, but higher returning assets, such as stocks, bonds, gold and foreign currencies. For seven straight months, the U.S. dollar has been under pressure as traders have focused on the massive debts America has been racking up and the potential that the once mighty greenback may be heading toward also-ran status.

Last fall, when America 's financial system was seized-up, and lenders were refusing to lend, the U.S. Federal Reserve decided to act boldly by flooding the system with dollars. With an avalanche of new dollars floating around, investors everywhere have become nervous that America may be in the process of debasing their its currency in an attempt to inflate away the massive debts it has been incurring to prop-up their ailing economy. And with an estimated deficit of $1.6 trillion in 2009, America is unquestionably the biggest debtor nation on the face of this earth.

The supply and circulation of U.S. dollars is tightly controlled by the Fed through its monetary policies. Unfortunately, central banks—the Fed being no exception—have a pretty poor track record of defending the value of their currencies. When push comes to shove, most central bankers are all too happy to print money and flood the financial system with increasingly worthless dollars, yen or Deutschmarks to pay off their country's debts.

But the U.S. dollar differs from all other currencies in that it is considered a reserve currency. Greenbacks are stuffed in central bank vaults around the world, since the U.S. dollar is the principal vehicle for global trade. But with the American government running up a staggeringly-large IOU tab, once eager creditor nations are openly talking about a replacement for the U.S. dollar.

China was the first major power to attack the greenback, calling for the dollar to be replaced as the world's reserve currency back in March, 2009. China is right to worry. China holds more U.S. debt than any other country—some $800 billion, and as the dollar falls in value against the Chinese Yuan, the less value of the U.S. debt owed to China. So far, the U.S. dollar has been taking it on the chin—declining fifteen percent against a basket of major currencies since early March.

Figure 1: Dollar Doldrums – The U.S. Dollar Is Under Attack

Source:Bloomberg

As I point out in my recently released book, Shell Shocked-How Canadians Can Invest After the Collapse (John Wiley & Sons), there is nothing sacrosanct about being a reserve currency. “During the nineteenth century, London , rather than New York , was the financial capital of the world and most commodities were priced in pounds sterling. Britain 's pre-eminence as a trading nation and its strong network of colonies helped propel London and the pound to global dominance. During that time, Britain was the world's largest creditor nation, as well as the leading exporter of manufactured goods and services. So dominant was Britain in trade and commerce that from 1860 to 1914, some 60 percent of global trade was invoiced and settled in pounds.

With the outbreak of the First World War, demands on the British Treasury became intense. As a result, in 1914 Britain switched from being a net creditor nation to a net debtor nation and became beholden to the rest of the world to fund its economy. The Second World War further depleted the British Treasury and Britain was forced to liquidate most of its international currency holdings to satisfy its war debts. By 1945, the U.S. dollar had replaced the pound sterling as the world's reserve currency and the pound began to decline in value. In 1956, a run on the pound caused the currency to collapse and forced the British government to seek a financial bailout from the International Monetary Fund.”

While it is extremely unlikely that the U.S. dollar will be replaced as the world's reserve currency in the next two or three years, it will likely continue to weaken from current levels. And that has already begun to fuel a rally into hard assets such as copper, silver, platinum and crude oil, since commodities typically hold their value, even if the dollar doesn't.

One big beneficiary of the flight from U.S. dollars is gold. Demand for gold is increasing as U.S. government debt reaches record levels and interest rates remain near zero percent. So far, gold is up over 19 percent this year and with concern over the stability of the U.S. dollar increasing, gold prices will likely head higher.

Historically, gold zigs when the U.S. dollar zags. And with the growing perception that Washington, and other policy makers around the world may welcome a slow but sustained depreciation of the U.S. dollar, gold and gold stocks are turning into a savvy bet.

Investors who are concerned about the slide in the U.S. dollar, should consider hedging their bets by taking a position in a gold exchange traded fund (ETF) or senior gold producing stock. A massive trade into hard assets is in its nascent stages, as the world begins to slowly grow again and concerns mount over the long-term value of the U.S. dollar.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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