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“But a funny thing happened to all those dollar bears. Their contempt for U.S. economic freedoms hasn’t amounted to a hill of bill of beans, and their positions have been smoked…Buffet, who reportedly lifted his bet against the buck to a position of $22 billion and counting in the first quarter this year, isn’t sounding quite so smug anymore…he has had his head handed to him by more experienced currency players.”
Jon Markman. How Buffett Tripped Over The Dollar
Warren Buffett began betting against the dollar when the Euro was at 86 cents US, and from 2002-2004 Berkshire reported a $2.962 billion profit from its foreign currency dealings. Having faith that readers are ignorant to these facts, Jon Markman ignores them completely and instead tries to argue that a 6-month rally in the dollar means that ‘Berkshire investors suffer’.
That Markman and others are attacking the so called ‘dollar bears’ is proof that a US Dollar sentiment shift - from nearly universal bearishness 6-months ago to widespread bullishness today - is afoot. Furthermore, with the Euro threatening to lose its reserve to the reserve currency status, and the global economy showing signs of slowing down, there is evidence that old habits are reemerging. The old habit in question being that when all else fails buy the US dollar.
But whether or not old habits can build a sustainable floor underneath the US dollar remains to be seen. Indeed, so long as the US current account deficit continues to swell the world will continue to edge towards a way out of US dollar/US consumer dominated world.
Potential Death of the Euro Not Exaggerated Enough?
“Nowadays, of course, no one doubts euro’s positive outlook.” Kudrin. June 12, 2005
Following the French and Dutch no votes speculation began to swirl that the Euro was doomed, that the ECB would soon cut interest rates for the first time since 2003, and that no one in Euroland was particularly upset by the fact that the Euro was declining (you might remember that in late 2004 officials were actually contemplating intervention to slow the steamrolling Euro down). Suffice to say, unless Russian Finance Minister, Alexi Kudrin, was being misquoted, at least one high ranking official in Russia is completely oblivious to the fact that the Euro’s outlook is anything but positive.
Has The ‘Diversified Reserves’ Experiment Failed?
One of the reasons why Russia is not admiring the potential danger of Euro weakness is because in recent years Russia has shifted its reserves away from dollars and into Euros. Indeed, Russia reportedly holds 30% its reserves in Euros, and is one the largest buyers of Euros today. As for the rest of the world, talk of diversifying reserves (into primarily Euros) was running wild in late 2004 but is at a standstill today.
While a stronger dollar is largely responsible for the end of the DR experiment, one related question also rings loudly: Diversify into what?
This is the question that Markman is asking. Oddly enough, some long-term dollar bears are indirectly asking this question as well.
If You Can’t Beat Them, Join Them?
Last month bond king, Bill Gross, capitulated and entered the bond bull camp. Two weeks ago Stephen Roach did the same.
“…demand for Treasuries should continue at high levels from foreign central banks due to the continuation of Bretton Woods II…we believe a range of 3 - 4½% for 10-year nominal Treasuries will prevail during most of our secular timeframe”
Bill Gross, The Strange Tale of the Bare-Bottomed King
“I have thought long and hard about this and have now concluded that I may be guilty of having overlooked a critical aspect of the interest rate piece of an external adjustment. In the end, what foreign creditors seek in a current-account adjustment is a relative premium for taking currency risk…So call me a bond bull for now”
Stephen Roach, Rethinking Bonds
That Gross is becoming a Bretton Woods II believer and Roach is suggesting that the US current account deficit may be sustainable is, to say the least, shocking. Quite frankly, for anyone that has understood Roach’s previous theories* the following statement is heresy:
“As long as spreads widen between the US and other international interest rates, that may be sufficient compensation for America’s foreign lenders.” Roach
Despite lacing their opinions with countless caveats, by their own words Gross and Roach’s bond bull call is both foolish* and imprudent (at least over the long-term). Nevertheless, by becoming bond bulls Roach and Gross have, indirectly, also become US dollar bulls.
“It isn’t prudent for U.S. citizens to continue to expect to consume 6% more than they produce, nor is it rational for investors to expect foreign central banks – primarily the Chinese and Japanese – to invest that 6% surplus and other direct investment monies into the U.S. Treasury market forever...”
Gross
Death of the Bears?
The near term question impacting the US dollar is diversify into what? After all, without a legitimate investment alternative to the US dollar BWII lives, US interest rates do not spike higher, and someone as biased as Markman myopically can attack a humble billionaire like Buffett.
“For the foreseeable future, the greenback will continue to denominate, and dominate, world trade. And it is only a matter of time before Buffett announces he is returning to matters he understands better than world currency flows...” Markman
Despite the dollar’s rally and the BWII dynamic that is at work, Markman’s conclusion that Buffett will exit his currency positions (supposedly for a loss?) and admit he didn’t understand what he was doing may be wishful thinking. What Markman doesn’t realize is that Buffett is using foreign currency forwards partially as a hedge against Berkshire’s dollar exposure. In other words, Buffett has already answered the magic question - diversify roughly 10% of assets away from dollars - and, like Russia, is not likely to flip flop back into US dollars simply because the dollar is rallying.
Along with the long-term dollar bears like Buffett who have diversified some capital away from US dollars, the commercials are also unlikely to exit their positions because of a dollar bounce. Many have tried to argue that the commercials do not know what they are doing (i.e. that a squeeze in gold is due because of commercial short covering), and they have time and time again been dead wrong. That the commercials continue to accumulate a larger net dollar short position suggests that a correction in the dollar is drawing closer.
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Lastly, with inflationary pressures in a holding pattern and the Euro headed lower, gold has tried to reestablish itself as the currency of the last resort in recent sessions by decoupling from the dollar. Eventually all fiat currency fails and gold succeeds as the safe haven choice for investors. Nevertheless, to argue that a few sessions of decoupling - i.e. rising dollar and rising gold - means much of anything could be dangerous. What gold will need to reestablish new highs and cleanly break its bond to the US dollar is financial market upheaval and/or a specific answer to the big question: diversify into gold!
In short, the US current account deficit is showing no sign of contracting, the commercials have added to their record net short position, and the media is starting, again, to say that Buffett is washed up. These are signals of a dollar top. As for ‘all of those dollar bears’, some are hibernating while others are not overly concerned with a 6-month dollar rally, but none have officially been slaughtered.
* “After all, goes the logic, the world has learned to live with America’s outsize deficits. Why can’t it continue to do so indefinitely? In my view, this is yet another example of the “greater fool theory” that took NASDAQ to 5000 four and a half years ago. All the classic symptoms of a US current-account adjustment are now evident. The funding of America is an accident waiting to happen.”
Roach, The Funding of America. April 23, 2004
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