A Melman Minute
By: Leonard Melman
Few subjects have received as much financial ink
during the past couple of weeks as the once-again respectable U. S. Dollar. We
are bombarded with stories about how the Greenback is surging against the Euro,
with that newest of major currencies having fallen all the way from US$1.60 down
to $1.55. In fact, based on some of the more optimistic media reports, one could
almost get the idea that the world was entering a new era of sustained U.S.
Dollar strength.
This anticipated strength has been interpreted as one of the prime causes for
the relatively weak performance of commodities in general over the past short
while, omitting for the moment the fact that the whole petroleum complex roared
to the highest levels in recorded history just a few days ago.
One article released this morning and authored by Associated Press reporter
George Jahn, quotes Victor Shum, an analyst with Purvin & Gertz of Singapore, as
noting, “…the strengthening dollar has capped further gains in oil.” Jahn also
writes that the fall in oil on Thursday was, “…helped by the rising U.S. dollar,
which now stands above 105 against the Yen and near 1.55 against the Euro.” He
then adds a most important concept, one we believe is currently being accepted
by many market analysts, “A rising (US) dollar undercuts the appeal of
commodities such as oil as a hedge against inflation, and makes oil more
expensive to investors overseas.”
We have also noted that other market analysts have attributed gold’s recent
decline from near (all prices US$) $1,030 to below $850 per ounce at least in
part to concerns about a strong Greenback.
So, let’s take a close look at some concepts about US Dollar strength.
While there are indeed many differing components of U.S. Dollar price movements,
in our opinion, four interrelated factors seem to carry particular weight. These
are:
-
The rate of American fiat money creation
-
Size of U.S. budgetary deficits
-
Size of U.S. Balance of Trade Deficits (or
surpluses)
-
Present and anticipated levels of interest
rates.
It is interesting to compare these factors against
the long-term performance of the United States Dollar against one other currency
that has been held in high esteem during the past several decades, the Swiss
Franc, or “Swissie”. Our chart examines that currency’s performance over the
past thirty-plus years, since the mid-1970s.
As can be observed, from 1975 1979, the Swissie rose steadily from barely 38
cents U.S. to almost 70 cents. And what were some of the conditions making up
the financial background in America? Unemployment was rising, inflation was
rising, budgetary deficits were rising, interest rates were rising (reflecting
rising rates of inflation) and a feeling of, as President Carter put it,
“malaise” was infecting America.
Then the Reagan Era arrived when strong attempts were made to limit government
spending and interest rates were driven artificially high to stamp out
inflationary expectations. As a result, the Swiss Franc sank and the Greenback
soared, recovering all the declines of the previous few years and then some.
From 1984 until 1995, expectations changed swiftly. Huge deficits plagued the
Reagan Administration, money creation accelerated, an expensive war was fought
in the Persian Gulf and, among other factors, the Clintons’ (plural fully
intended!) first Administration seemed headed toward an era of further
government expansion. As a result, the Swissie grew stronger during that period,
reaching a then historic high at 90 cents U.S., far in excess of the 1979 peak.
However, America’s economy improved dramatically with the arrival of the
“dot.com” bull market frenzy and, perhaps surprisingly, the government’s long
record of deficit spending was replaced by budgetary surpluses - and the
Greenback strengthened once again until the first year of this century.
During the past seven years, monetary matters once again have made a 180 degree
turn, a turn, in our opinion, to the wrong direction if stability and strength
of the U.S. Dollar were the goals. Deficits have returned with a vengeance. New
and enormously costly wars have been undertaken in both Iraq and Afghanistan.
Balance of Trade deficits have exploded upward. Monetary creation has reached
exceedingly high levels by historic standards. And, importantly, interest rates
reflect even further easing of monetary policies which historically have led to
rampant monetary creation, rather than those which might reflect a serious fight
against future inflation. As a result, since 2001, the Swiss Franc has reached
historic new highs - and the recent dollar strength appears on the long-term
chart to be nothing other than a tiny correction inside a clearly negative trend
for the American currency.
It is our opinion that these trends toward rising budgetary and trade deficits,
escalating monetary creation and interest rates which are being held at
artificially low levels will continue and we believe that further U.S. Dollar
weakness has been built into the system. We opine that this will become evident
in coming weeks and months - and that such weakness - if it eventuates as we
expect - will be a positive factor for all commodities, specifically including
base and precious metals, during the second half of 2008.
Markets this morning have opened mixed with the Dow down by about 30 points and
TSX up by over 80 at about 7:00 AM PDT. Gold is rallying in early trading,
having risen back to the $870 level while silver and platinum are also strong,
up about 40 cents and $20 respectively. Crude Oil is stronger on reports of
disturbances in Nigeria, trading once again above $118 per barrel and the U.S.
Dollar is close to unchanged. Base metals are sharply higher, led by copper
reacting to news of serious labor problems in South America.
One important story that is just now taking place involves what appears to be
serious food rioting in Mogadishu, Somalia. We believe the food crisis is one of
the most important developing stories and we offer two concepts for our readers
to consider.
First, in Canada and the U.S.A., the cost of food take up about 30% of the
average family’s budget/ Therefore, if food prices rise by about 40%, for
example, that would mean an overall increase of about 12% in the family’s total
expenditures. However, in many developing countries, the cost of food is the
major expense component, estimated to involve as much as 70% or more of a
family’s funds. So, if food costs rise by 40% - as they have been doing recently
for staple products - the effect can be crushing
Second, most of our food in the developed nations is processed, meaning the cost
of the raw food ingredients is only a small portion of the overall costs,
thereby mitigating any effect of rising basic food commodity prices. In Third
World nations, however, the basic food frequently is the consumed product
meaning the full force of any price increase must be borne directly.
We will look further into this picture tomorrow.
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