The dollar makes a new low
On Friday, December 15th, the dollar fell to a 15 month low against the Euro. It appears as if Alan Greenspan is caught between the proverbial rock and a hard place. He will be hard pressed to save the economy from a recession without sacrificing the dollar in the process and in fact, I don’t even believe that he can save the US economy from a recession at all. The reason for my pessimism is that the boom we have experienced during the past decade was financed with a ludicrous amount of debt and the events that have enabled the US economy to defy logic may have run their course.

The party’s over
70% of worldwide net capital movements are currently going into the United States and over 80% of the foreign direct investment in the US comes from Europe, which is why the dollar has been so strong for the last few years and why the Euro is so weak. For most part the US has remained the most attractive economy in the world due to its size, growth rate and relatively high interest rates, i.e. rate of return on capital. While it will remain the largest economy in the world, US economic growth appears to be slowing down and that should cause the Federal Reserve to start lowering interest rates, therefore reducing the allure of the dollar.

The "wealth effect"  is real, and it will be devastating when it reverses
The flood of foreign capital coming into the US buoyed bond prices, strengthened the dollar and, perhaps most importantly, stimulated US consumption. This in turn gave the economy a tremendous boost, led to a stock market bubble and resulted in a “wealth effect” of historical proportions. Between the New York Stock Exchange and NASDAQ, more than $13 trillion were created during the past 10 years (the NYSE capitalization increased by 340% and NASDAQ’s capitalization increased by more than 1,000%). That equates to roughly $47,000 for every man, woman and child in the United States or $125,000 per household. Considering that the median income per household is only $41,000 per year, this newfound wealth stimulated unprecedented consumption on the part of a community that is already prone to consumption.

Consumption and debt expansion
Foreign capital investment and the expansion of debt in the US supplied the fuel that fired the US economy. It wasn’t a “new era” after all, just an old fashioned increase in the money supply. During the past ten years, corporate debt increased by 88% to $4.6 trillion, household consumer credit expanded by 92% to $1.5 trillion and household mortgage debt soared by 82% to $4.9 trillion. Not to mention the US public debt, which now amounts to $5.7 trillion, or $54,000 per household, and which is growing at the rate of $123 million per day. On top of this, the savings rate in the US has declined from 7.8% in 1990 to virtually zero today. The wealth effect caused people to spend more money than what they otherwise would have and most of this “excess” consumption was financed with debt. It also caused unbridled speculation on the part of investors.

Too much exposure to the stock market can be hazardous to your financial health
More than 50% of American households now own equity investments compared to less than half that amount in 1929. Just in the last ten years, the number of households with stock investments has doubled. A decrease in the stock market will send the “wealth effect” in reverse choking off consumption and exacerbating the consequences of debt engorgement.

Personal and corporate debts are starting to default
US financial institutions are beginning to feel the consequences of their uninhibited lending practices. The surge in both corporate and consumer debt during the past decade was only sustainable while the economy raced along at break-neck speed. Now that the economy is slowing down, the chickens are coming home to roost. Just as the increase in debt fueled the economy and the growing economy sustained the increase in debt, so too should a slowing economy cause much debt to go into default and that should result in a further slowdown in the economy. While Americans were spending themselves rich, they will now have to face the reality that borrowing money can rapidly lead to poverty when the good times end. And I doubt whether this is going to impress foreigners sufficiently to attract their capital.

How can we profit from all of this?
It may appear as if I am a pessimist. Not at all. As a speculator I am always trying to understand the cause of events and hence the possible outcome of a situation. In the case of the US economy, I am quite convinced that the US dollar cannot sustain its current exchange rate with the rest of the world’s currencies. In part because I believe the US economic miracle is being exposed for the folly that it really is and in part because the incredible US trade deficit will exert tremendous pressure on the dollar to decline.

Gold is quoted in US dollars and if the dollar falls, the price of gold should rise. There is probably no other speculation as compelling right now as buying gold and gold related equities. Unlike currencies, gold is no-one else’s liability. We all have to make our own decisions based on the limited knowledge and abilities inherent in each of us. Only time will tell who was right and who was wrong.