International Living's Saturday Essay: Is Jack Crooks insane? He believes the U.S. dollar is entering a long-term bull market. In the report that follows, he explains how you can profit while the world plays catch-up.
International Living Postcards--your daily escape
Saturday, March 21, 2009
Dear International Living Reader,
What explains why the financial system crumbled…why the global economy is sinking…and why the U.S. dollar is the best looking currency around?
Look no further than “tight coupling.”
Tight coupling exists throughout the financial markets. A good example would be the recent subprime mortgage-backed securities scenario. Everything was hunky-dory but then:
- Home prices started falling…
- Borrowers were unable to afford loans…
- Bundled loans became less attractive…
- The market for this newly-created product froze up…
- Losses started piling up for investors in these bundled assets…
Finally, investors who had never touched mortgage-backed securities experienced losses, as the tightly coupled financial industry unwound and asset values across the board deteriorated.
Decoupling Predictions Proved to Be Wrong
In hindsight we realize how flawed the idea of decoupling was. The U.S. economy is still the big dog pulling the global economic sled.
But as recently as the middle of 2008, market bulls clung to the hope that the global economy would decouple from its dependence on the U.S. And why not? The global economy was chugging along:
* Emerging markets provided raw materials and input products to China.
* China gobbled up these raw materials and produced consumer goods to sell to the developed world.
* The developed world supplied the global capital necessary to keep the growth circuit unbroken.
The profit potential was huge. Many abandoned dreary U.S. investments in search of more-lucrative returns.
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Of course, “more lucrative” implies “more risky.”
When emerging economies plowed their trade surpluses into their lop-sided export-centric growth models, they neglected to invest in their domestic sectors. Their leftover capital was instead shoveled into the U.S. in exchange for safer returns.
Risk takers Stampede To Safety
The problem arose when the U.S. could no longer find places to channel trade surpluses that overseas economies were pumping into our capital markets.
All sorts of new derivative products and investment avenues became accessible…in hopes of allowing liquidity to flow efficiently. But of course, as is the case with tight coupling, the complexity of new initiatives opened the door for error.
Asset bubbles inflated and popped as investors realized they had little understanding of new financial instruments. Consumers watched their stock market and housing wealth evaporate. Spending across developed nations retreated--and export-centric growth models suffered as global liquidity vanished.
For all these reasons, global capital flow has morphed. Many markets dependent upon steady liquidity have become extremely correlated, as often occurs in times of crisis. What this has done is create a stampede away from risk-taking and towards risk aversion.
In other words--a run on the U.S. dollar.
In Such an Environment, It’s All Relative
If these ideas are new to you, then you’re probably thinking one of two things:
1. This guy Jack Crooks is insane. Doesn’t he know the U.S. dollar is doomed?
Or…
2. This makes some sense. But how can the U.S. dollar escape the awful fundamentals staring it right in the face?
If you think I’m insane, you might be right…but for the wrong reasons!
You see, in the game of foreign exchange--one currency is paired versus another currency--it’s all relative. And if you automatically think the U.S. dollar is relatively worse off than other currencies, you might want to think again. Since the global economy has gone on the fritz, the U.S. dollar’s relative fundamental backdrop has actually improved dramatically.
The global financial meltdown started this mess. And the crisis won’t come to an end until banks are able to overcome the burden of insufficient capital, dysfunctional lending and borrowing, and toxic assets.
But consider…
* U.S. bank liabilities sit at levels equivalent to 85% of U.S. GDP. However, bank liabilities of Switzerland, the United Kingdom and the Eurozone sit at 650%, 430% and 320% of their respective GDPs.
* Cross-border lending by U.S. banks to emerging markets in Eastern Europe, Asia and Latin America totals the equivalent of 4% of U.S. GDP, whereas the same figure sits at 24% and 21% of the respective GDPs for the United Kingdom and Europe.
* European bank exposure to emerging markets is roughly six times the size of U.S. subprime mortgage-backed securities. With that in mind, I’m partial to the U.S. as a far more capable candidate to weather this financial storm.
Profit While the World Plays Catch-Up
European and Australian central banks are now scurrying to play catch-up to the Federal Reserve and cut back interest rates. That alone is a driver of the currency market as the once negative interest yield spread on the dollar is improving.
Now I’m not saying it’s become an even playing field. I’m not sure that’s even possible. But it’s getting about as close as it can to becoming one. And in such circumstances, the U.S. dollar has a lot going for it that other currencies don’t have.
As this cleansing cycle runs its course, risk-aversion and de-leveraging will continue to steer capital back to the U.S.--and the dollar will remain the quintessential safe haven currency. Despite the warts in the U.S. system, it still remains the most flexible of all the major economies. Just consider all the things that our Fed and Treasury have already tried and abandoned. Many say that zaps confidence and proves the U.S. system’s weakness.
I beg to differ. I say it proves the U.S. will do whatever it takes to get us out of this mess and do it a lot faster than the other major countries. That’s a huge strength!
I am confident the U.S. will be the first to emerge from this global morass. And that will be the catalyst for a whole new level of international investment flowing to the world’s major economy.
A long-term bull market in the U.S. dollar is in the making. It’s time to hop on board.
Jack Crooks
Editor, The Money Trader
Editor's note: Jack Crooks is known as “the trader who never sleeps.” Up by 5.00 a.m. each weekday, Jack scours the news and market action of currencies all over the world, mapping out his medium-term trading strategies in currency options and the spot market. With a typical trading time ranging from five days to three months, Jack gives his readers plenty of time to act and profit from his significant moves in the forex market. Read more about The Money Trader here.
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