The US Dollar – The “Strongest of the Weak”

The US Dollar – The “Strongest of the Weak”

The idea of risk is a very personal thing.

What we see as risky, you may not.

And what you see as risky, we may see as completely safe.

One trick to successful investing isn’t to just figure out what you see as risky, but to also figure out whether other investors see it as risky too.

If you can pull off that trick it can help you stay one step ahead of the crowd. More below…

The following headline from Bloomberg News caught your editor’s eye this morning, ‘Dollar Scarce As Top-Quality Assets Shrink 42%’.

‘Dollar Scarce’?

It doesn’t seem possible.

After all, you’ve no doubt seen this chart from the Federal Reserve Bank of St. Louis:

Federal Reserve Bank of St. Louis

Source: Federal Reserve Bank of St Louis


It shows the explosion of US dollars on issue since 2008.

How can US dollars be scarce when the monetary base has increased from USD$800 billion in 2008 to USD$2.7 trillion today?

The answer is risk.

The Bloomberg News story explains more:

‘International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The US is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category…’

For the past four years, most of the talk has focused on the US. And most of that talk has centred on the US budget deficit, government debt and the devaluation of the greenback due to money-printing.

To some degree the US dollar has taken a back seat as markets and commentators focus on the euro…and its inevitable demise.

Just as it looks like the euro crisis is over, another spanner gets jammed in the works. The latest problem is with Spanish bank, Bankia S.A.

The Weakest of the Weak

Overnight, the European Central Bank (ECB) rejected the Spanish government’s proposal to prop up Bankia. We’re not surprised. It was nothing more than an indirect way of Spain tapping the ECB for a bailout.

The Spanish government had proposed issuing a bunch of debt to Bankia, which it could then use as collateral with the ECB. The ECB saw through this snide plan and so it looks like the Spanish government will have to bailout Bankia directly…undoubtedly causing the Spanish government to go further into debt, with Spanish bond yields going higher.

As the chart below shows, Spanish government bond yields are now near the highs of last November:

Spanish government bond yields

Source: Bloomberg


So, why are Spanish bond yields going up? Because big investors see Spain as too risky. Only last week savers withdrew 10% of deposits at Bankia on fears it would collapse.

As Slipstream Trader Murray Dawes told us this morning, ‘Why would you believe what the other banks say? You’d sell now and ask questions later.’

But with European nations holding a single currency, grouping together basket-cases like Spain with non-basket-cases like Germany, it’s not just a case of selling Spain and buying Germany.

However, many investors are doing that, which is why German 10-year bond yields are at a record low of 1.36% (During the market crash of 2008, the 10-year bond yield barely dipped below 3%).

But when push comes to shove, investors are going where they’ve gone during every previous crisis – the US dollar and US bonds.

The Strongest of the Weak

At the end of March, foreign holdings of US government bonds totalled USD$5.1 trillion. That’s a 14% increase from the same time last year. 10-year U.S. government bonds are trading at 1.7% – a higher yield than German bonds.

As risky as the US dollar seems, investors are still willing to buy it.

So, what’s the takeaway from this?

Simply this: as expected you’re seeing investors migrate from the weakest of the weak and towards the strongest of the weak.

You could say it was the next logical step towards the end of paper currencies. If you’re worried about your Spanish savings, you sell them and buy German savings. You hold those until you’re worried about the safety of your German savings.

After that, it’s into the lap of the world’s reserve currency, the US dollar.

How can you tell when that’s started to happen? We can’t say for sure. But a likely sign is in the following chart:

Spanish government bond yields

Source: Bloomberg


The orange line is the US government bond yield. The green line is the German bond yield. German bond yields have fallen as investors seek the safety of German assets over other European assets, to the extent that yields are lower in Germany than in the US.

The signal that investors are genuinely fearful over the future of the euro (rather than just Greece leaving the euro) will be when the green line starts ticking up and perhaps even rises above US bonds.

That should tell you that one more paper currency is about to fail as money flows into the strongest of the weak – the US dollar.

This is a key chart to watch over the coming months.

Cheers,
Kris.

P.S. My old pal, Australian Wealth Gameplan editor, Dan Denning recently published a report explaining how investors can potentially profit from globally falling yields. To check out how Dan recommends his readers do this, click here.

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Kris Sayce

Kris Sayce

Publisher and Investment Director at Port Phillip Publishing
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the editor of Tactical Wealth, and Microcap Trader — where he reveals the best opportunities he’s discovered in the markets. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.
Kris Sayce is the Publisher and Investment Director of Australia’s biggest circulation daily financial email, Money Morning Australia.Kris is a fully accredited advisor in shares, options, warrants and foreign-exchange investments. Kris has close to twenty years’ experience in analysing stocks. He began his career in the biggest wasp’s nest in the financial world — the city of London — as a finance broker back in 1995.
It’s there where he got his ‘baptism of fire’ into the financial markets, specialising in small-cap stock analysis on London’s Alternative Investment Market. This covered everything from Kazakhstani gold miners to toy train companies.After moving to Australia, Kris spent several years at a leading Australian wealth-management company. However he began to realise the finance and brokerage industry was more interested in lining its own pockets with fat fees, commissions and perks —rather than genuinely helping out the private investors they were supposed to be ‘working’ for. So in 2005 Kris started writing for Port Phillip Publishing — a company which was more attuned to his investment outlook. Initially he began writing for the Daily Reckoning Australia— but eventually, took over Money Morning. It’s now read by over 55,000 subscribers each day. Kris will take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money! Whether you agree with him or not, you’ll find his common-sense, thought-provoking arguments well worth a read. To have his investment insights delivered straight to your inbox each day, take out a free subscription to Money Morning here. Kris is also the editor of Tactical Wealth and Microcap Trader where he reveals the best opportunities he’s discovered in the markets that you could profit from. If you’d like to learn about the latest opportunity Kris has uncovered, take a 30-day trial of Tactical Wealth here or Microcap Trader here. Official websites and financial e-letters Kris writes for:
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