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Deleveraging Pushes Up the U.S. Dollar

Currencies / US Dollar Nov 26, 2008 - 01:51 PM GMT

By: John_Browne

Currencies In view of the economic crisis facing the American and global markets, the recent strength of the U.S. dollar has confounded analysts. After all, the global economic problems essentially emanate from the United States and one would assume that the collapse of our economy would drag our currency down. That has not, as yet, transpired. The explanation can be found in a financial concept known as deleveraging.


In recessions, cash is short, and businesses and individuals seek to raise cash by any means practical in order to prepare themselves for the tough times ahead. In a world in which U.S. currency is held as the global reserve, cash means U.S. dollars. In short, institutions and individuals are selling any asset that is not nailed down (stocks, corporate bonds, etc.) and buying U.S. dollars. This has resulted in plummeting asset prices and a rising dollar. However, this dynamic cannot exist in perpetuity.

It is completely rational for global financial players to be cautious. The roots of the present economic and financial crisis can be traced to the sort of wild speculation typical of all asset booms throughout history. However, unlike the great speculative asset booms which preceded the Great Crash of 1929/34 or the bursting of the South Sea Bubble in 1720, the boom just recently ended was also characterized by wildly excessive leverage and outright fraud.

Among the financial community, the wild speculation was so reckless that a web of opaque and misleading accounting standards were developed in order to hide the insanity from view. The powerful Wall Street lobby was successful in persuading President Bush to allow it a free hand to push aside the anti-predatory lending rules of some 50 States. This led to an unfortunate marriage of deceptive lending and fraudulent borrowing. Brought to a fever pitch by unbridled speculation, this unholy union gave birth to the sub-prime problem debacle.

Based on the notion that property values would continue to rise while the Fed continued to pump-in U.S. dollar liquidity, even so-called 'prudent' institutions such as banks invested heavily. The high returns led to massive executive bonuses. Many of the loans and investments in real estate were hidden further through the use of derivatives and off-balance sheet accounting. This 'camouflage' was tantamount to fraud. When these loans began to default a credit crisis was unleashed, as the financial 'players' could not trust one another. This led to a credit crisis.

It is wholly rational and necessary that the end of this madness has led to a great deleveraging or economic recession. It is unavoidable that institutions are withdrawing from the market, circling their wagons, and holding tightly to their remaining assets.

Investors, who borrowed cheap and plentiful U.S. dollars to invest abroad, have been forced to sell foreign assets for local currency and buy dollars to repay their debts. Even major corporations are repatriating funds from abroad to meet the domestic dollar cash demands. But the basic cause of the recent asset boom was an excess of U.S. dollars. These opposing forces of dollar demand and oversupply are currently battling for supremacy. At present, demand is in the driver's seat.

However, when the deleveraging subsides the inflationary effects of massive U.S. Government stimuli take effect and show through as rampant inflation. The dollar is then likely to stall and even plummet. Indeed, it is possible that facing depression, newly elected President Obama may devalue the U.S. dollar drastically against gold, just as his 'mentor' President Roosevelt did in 1934, but only after confiscating all privately held gold from American citizens.

In the short-term therefore, the U.S. dollar looks strong, but only in the short-term. Investors should think ahead and not get trapped in U.S. dollars or have their gold holding open to confiscation.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read Peter Schiff's new book For an updated look at his investment strategy order a copy of his just released book " The Little Book of Bull Moves in Bear Markets ." Click here to order your copy now .

For a look back at how Peter predicted our current problems read the 2007 bestseller " Crash Proof: How to Profit from the Coming Economic Collapse ." Click here to order a copy today .

By John Browne
Euro Pacific Capital
http://www.europac.net/

More importantly make sure to protect your wealth and preserve your purchasing power before it's too late. Discover the best way to buy gold at www.goldyoucanfold.com , download my free research report on the powerful case for investing in foreign equities available at www.researchreportone.com , and subscribe to my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc.  Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with."  A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

John_Browne Archive

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Comments

Christopher
29 Nov 08, 03:34
CDS's and the dollar

"In recessions, cash is short, and businesses and individuals seek to raise cash by any means practical in order to prepare themselves for the tough times ahead."

Yes, but that is not exactly what's happening. The critical shortage of dollars is going to continue as long as the US refuses to ban credit default swaps. The cash is not being horded to prepare for tough times ahead but for a black hole of CDS's that has been sucking dollars out of the system. This brings up another issue that I dearly wish all the "Guru's" out there would comment on. Why would the US cooperate with the rest of the world and ban CDS's? It's certainly not in our interest to do so as the current situation will cause the world to continue to have to obtain dollars, burn up their currency reserves, and leave the US (even with a 15 trillion dollar or more national debt), in solid control. As Mr Buffet told us in 2003, these are weapons of mass financial destruction. They are working brilliantly.


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