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It’s well to remember how cyclical things are and how fast they can change. There were a couple of times in both the 70s and the 80s when the US$ was so weak and moving so unpredictably (mostly down) that many European shopkeepers wouldn’t accept it. Now it’s once again the Superdollar, forming the majority of most Central banks’ reserves, and acting as the de facto national currency of at least 50 countries around the world. But things are going to change, at least cyclically.

The reason, as I’ve often pointed out in the past, is that the dollar is, in effect, an IOU nothing on the part of the US Government. The unit won’t be redeemed by its issuer for anything of value. Its issuer can crank out unlimited numbers of them, and at the same time its issuer owes trillions of them. As Charles DeGaulle famously (and correctly) pointed out in 1965, several years before the first dollar crisis: "What the United States owes to foreign countries it pays - at least in part - with dollars that it can simply issue if it wants to." He helped precipitate the crisis when he caused France to demand gold for its dollars at $35 an ounce, forcing Nixon to devalue the dollar, and renege on the promise to redeem them with gold in August, 1971. Since that time, the dollar might best be defined as a “floating abstraction.”

Right now the US imports about $400 billion more than it exports, a new record, after almost two decades of growing deficits. That’s $400 billion that won’t be bidding for domestic goods and services, driving up their prices, resulting in “inflation.” Instead, that money brings in that much in the way of Mercedes, Sonys and the like, increasing the volume of goods and damping price increases. The foreign trade deficit is a very good thing for the average American’s standard of living.

But it gets even better. Those dollars come back to the US to buy not hard goods, but more paper—stocks and bonds—holding down interest rates and driving up stock prices, making the average American feel even wealthier, so he can buy even more Mercedes and Sonys to keep the virtuous circle going. It’s a great deal for Americans. We print paper, in the form of dollars, dot-com stocks and government bonds, and trade them for real things you can use. DeGaulle should roll over in his grave.
Now pretend you’re back in grade school, where they used to give you a drawing with lots of errors and ask you “What is wrong with this picture?” Obviously, the market can’t find anything wrong with it at the moment. “So,” many might say, “what’s the problem? Things seem to be going along pretty well.” True enough. 

But at some point the trade deficit must, and will, reverse. Then dollars will start pouring back into the US, putting inflationary pressure on domestic prices. Foreign imports will dry up, putting pressure on the earnings of foreign manufacturers as well as Americans’ standard of living. What’s building up is a dollar crisis that will absolutely dwarf anything in the past. 

It’s hard to predict exactly what will set it off. Perhaps when the masses sense the current weakness in the stock market, stop buying, and start selling. At which point it could turn into a rout. Perhaps the gigantic debt load of American consumers or the fact their new houses are already stuffed to the rafters with goodies will keep them from buying. Perhaps some especially ill-conceived foreign adventure will shatter confidence. Perhaps the current election fiasco will evidence some cracks in the wall of confidence. Because, as far as I’m concerned, both the dollar and the stock market rest on nothing more substantial than confidence. And confidence can vanish like a pile of feathers in a hurricane. When the psychology that has placed the US on the same pedestal the Japanese were on in the late 80s changes, you could see a collapse of the dollar.

It has the makings of a disaster of historic proportions, although, for the moment, the dollar is still king. 

EUROS AND YEN

One reason for that is that the dollar is ubiquitous, and therefore the only real contender in the tripolar currency world it inhabits with the yen and the euro. Yen are really only used in Japan, euros are really only used in Europe. Dollars are absolutely everywhere. 

The Euro has, of course, been one gigantic, chronic disaster since it was created out of thin air on Jan. 1, 1999, at a nominal rate of US$1.17. If it’s true the dollar is an IOU nothing, then the Euro is a Who Owes You Nothing. At least the dollar is the liability of a specific government, which has sovereign control over a specific group of taxpayers it can fleece to meet its liabilities. The Euro is a construct as artificial and unstable as the old Soviet Union. But, since perception is reality in the financial world, people are perfectly willing to use it as a medium of exchange and a store of value. The problem is, however, that it’s not nearly as widely known, accepted or trusted a medium of exchange as the dollar. The dollar is known and accepted everywhere in the world; few people outside the EC even have a clue what the euro is.  And its record as a store of value has been dismal so far. So it’s just not as good a money as the dollar. 

The incipient bear market in US equities and the massive shake-out in the “new economy” will reduce demand for the US dollar. So far, reduced demand has been disguised by the simultaneous collapse of the Euro. Rising oil prices increase the demand for dollars, since oil is priced in dollars and the countries selling oil usually keep their deposits in short-term dollar deposits. It was doubly clever of Sadaam to demand that the receipts from Iraq’s oil sales be kept in Euros. First, it hurts and embarrasses the US Government. Second, he’s getting out of the hot-potato dollar for a unit that may have, at least temporarily, bottomed.

I don’t, however, think the euro is going to survive the next decade. Or, if it does, it will be as an obscure accounting unit between governments, like the IMF’s SDRs. The reason is that governments are very big on using monetary policy to stimulate their national economies and printing currency to pay their bills. The euro, with its independent, albeit incompetent, monetary authority is very inconvenient for them. The theory of the euro is one thing in a booming world economy. But likely to be something else again when the going gets tough. 

However grossly overpriced at its inception; now that it’s fallen 26% (reaching what was probably a low of 82.85 cents on Oct. 26), it seems to me more or less reasonably-priced. 

There is, however, a practical speculative alternative to the US dollar.

THE NZ DOLLAR

The world’s weakest currency since January 1—not counting units issued by Afghanistan, the Congo and surprisingly few other places that are currently in that class—has been the New Zealand dollar. It started down from a recent high of about 70 cents US in 1996, drifting down to about US$.50 this time last year (at which time it became a genuine bargain), then

collapsing a further 25% to its current level of US$.40. It’s actually been as low as 38.5 cents. I consider this a true anomaly. It’s at once a superb speculative opportunity and a great means to diversify some assets out of the grossly overpriced US dollar.
 

Why has the kiwi fallen so far? Part of it is simply the strength of the US$, which is up against every other unit in the world. Part of it has been the weakness for wool, meat, dairy, timber and other basic commodities in recent years. The world has needed fewer NZ dollars to acquire the main things the country produces.

A big part of it over the last year is surely the socialist government that was elected there last November. These are not just an ordinary bunch of knuckleheads going through usual drill about stealing from the rich and giving to the poor, or even the old-style cloth cap-wearing, working man’s socialists. These people are very New Class, with academic backgrounds, which means they’re totally divorced from both “the people” and reality. The kiwi crash corresponds more closely to their election than anything else I can think of. 

A currency is, in many ways, tantamount to stock in the government that issues it; when you look at who these people are and what they’ve done since their election, it’s easy to see why the kiwi dollar has cratered.
 

Under NZ’s parliamentary system, these people may or may not stay in office until their term expires in Nov 2002 but, since they’re ideologically driven, they’ll continue to do their worst until then.

That being said, I’d say the collapse is way overdone. My main rationale for this belief is based on the Purchasing Power Parity (PPP) theory.

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