Why is the US-Dollar rising?

Dear PGM Capital Blog readers,
In this weekend’s blog edition, we want to discuss with you why the US-Dollar has been rising since mid May of this year, despite the fact that the long-term health of the world reserve currency is still as precarious as it ever was and the fact that the national debt is currently over 108 percent of its Gross Domestic Product.

THE USA NATIONAL DEBT:
The Outstanding USA Public Debt on Saturday November 1, 2014 at 5:00 PM GMT was:

On top of this, the US National debt is rising with approx. 2.5 billion US-Dollar a day, which means that before the end of this year, the USA will have a national debt of over 18 trillion US-Dollars.

THE USD INDEX:
The US Dollar Index (USDX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies.

It is a weighted geometric mean of the dollar’s value compared only with a “basket” of 6 other major currencies which are:

• Euro (EUR), 57.6% weight
• Japanese yen (JPY) 13.6% weight
• Pound sterling (GBP), 11.9% weight
• Canadian dollar (CAD), 9.1% weight
• Swedish krona (SEK), 4.2% weight
• Swiss franc (CHF) 3.6% weight

USDX started in March 1973, soon after the dismantling of the Bretton Woods system. At its start, the value of the US Dollar Index was 100.000. It has since traded as high as 164.720 in February 1985, and as low as 70.698 on March 16, 2008.

As can be seen from below chart, the U.S. Dollar Index, is up 8.6% this year.

But this is more an indication that traders are bearish on other currencies, as opposed to bullish on the dollar.

The index is comprised of various currencies, each assigned a certain weight that goes into determining the index’s final figure. The bulk of the calculation comes from the Euro, which makes up 57.6% of the index, followed by the Japanese yen at a 13.6% weight, and the British pound sterling, which comprises 11.9%.

Together, these three currencies represent 83.1% of the index and explain why the main dollar index has been performing as well as it has this year.

THE POUND STERLING:
As can be seen from below chart, the GBP/USD ratio has been on the way down for a few months now, dropping from US$1.72 to to close on Friday, October 31st on its lowest on the year of US$1.5995.

THE EURO:
European economic policymakers and central bankers are losing their appetite for wide-scale austerity measures and instead are more explicitly advocating inflationary monetary policies to jump start the region’s stagnating economy.

Plagued by an elevated unemployment of 11.5% and troubling indicators signaling disinflation, the austerity calls are being hushed by much louder cries for stimulus.

Due to this at the end of their meeting of September 4th 2014, the ECB announced starting September 10:

• The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.05%
• The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30%.
• The interest rate on the deposit facility will be decreased by 10 basis points to -0.20%.

On top of this they announced to buy non-financial asset-backed securities to the tune of 500 billion euros over three years.

This will all contribute to a weakening of the euro, and already has helped to prop the dollar up.

As a consequence of this the Euro depreciated against the USD from US$ 1.393 in March of this year to US$ 1.2526 at the close of the trading day of Friday, October 31, 2014, as can be seen from below chart.

“ABENOMICS” WEAKENS THE JAPANESE YEN:
“Abenomics” is made up of three main elements called “arrows” that include monetary easing, flexible fiscal policy, and structural reform. Since its inception in 2012, the Yen has fallen more than 23% as can be seen from below chart.

 

The first two arrows are the main culprits behind the yen’s plunge.

If this isn’t enough, on Friday October 31, in a tight vote, the Bank of Japan backed an 80 trillion yen (U$720 billion) target for expanding the monetary base (a measure of the amount of money held by the central bank and in the economy). That’s up from a previous target of 60 trillion to 70 trillion yen.

This was a major unexpected move by Haruhiko Kuroda, the Bank of Japan’s governor, and a big new chapter in the country’s “Abenomics” experiment, named after Prime Minister Shinzo Abe.

The Dollar and Yen are reacting pretty much as one would expect, too, for which the Dollar went up 2.23% against the Yen to close the week of and trading day of October 31 at 112.3150 its highest level since 2008.

Due to this the USD Index went up on Friday, October 31, 2014, with US$ 0.75 or 0.87%, to close at US$ 86.92 its highest level since mid 2010 as can be seen from below chart.

PGM CAPITAL COMMENTS:
Since mid May of this year the US-Dollar Index has been risen with almost 9%, which is a huge move for any currency to make in such a short period. Due to this the dollar might be on a fragile footing at the moment and likely can’t sustain this rise.

The threats for the US-Dollar going forward are more likely than most people think. A stronger US$ hurts the already fragile US exports and also the consolidated earnings from USA multinationals, when they convert their earnings abroad in a higher US-Dollar exchange rate.

Even more troubling are the threats to the US-Dollar hegemony from China and Russia. The two countries are settling more international transactions in their own currencies, effectively bypassing the dollar altogether.

As a consequence of a rising US-Dollar, the price of Crude Oil, Gold and other precious metals, which are measured in US$, received a haircut.

Due to this, China as the biggest holder of US treasuries securities but also Russia, might see the current high and unsustainable USD-Index as a good momentum to SELL (some of) their US treasuries holdings in order to buy Gold at depressed price.

These cues could signal that two major economic powers are weaning themselves off the dollar, further threatening the U.S. dollar’s value in international markets

Right now, there’s little doubt that their respective QE-programs and subsequent weakening Euro, Japanese Yen and British pound currently are providing tail wind to the Dollar. But on the other hand, based on its balance of payment, country debt – which most probably will reach 18 trillion US-Dollar by mid December 2014 – we can conclude that the value of the US-dollar currently is overstated, is in a bubble and that it is not IF but WHEN, the market will see this and send the US-Dollar into a correction to a more realistic value.

The other aspect of the trade of the US-Dollar is Gold, which is down due to the increasing US-Dollar.

As can be seen from below chart, the Chinese have used the lower Gold price to increase their demand for the yellow metal.

Above chart shows the latest weekly withdrawals figure from the Shanghai Gold Exchange (SGE) in the week of October 20, which hit 59.7 tonnes, making the total Chinese gold demand – so far this year – over 1,600 tonnes. And if the big weekly withdrawal figures continue for the rest of the year, Chinese demand is again on the way to the 2,000 tonnes mark.

But the biggest support for Gold last week came from former FED Chairman Mr. Alan Greenspan, who, according to Wall Street Journal reporter Michael S. Derby said

“Gold is a good place to put money these days given its value as a currency outside of the policies conducted by governments.”

We believe that Mr. Greenspan’s statement cannot be seen as a short-term statement but that he was clearly looking forward.

Based on the above we are currently adding Gold and other precious metals to our personal portfolio and at the same time we are shorting the USA Markets and the US-Dollar in order to profit from the (coming) correction in US-Equities and the US-Dollar.

Before following any investing advice, always consider your investment horizon and risk tolerance and financial situation and be aware that stock prices don’t move in a straight line.

Until next week.

Yours sincerely,

Eric Panneflek