With the US in such a precarious debt situation, why is the dollar strong and gold weak? In response to this question asked by a number of readers, let me say this: no one can predict when the seemingly inevitable decline in the US currency and US bonds will unfold. Yes, the dollar fundamentals are negative. As I’ve frequently warned in Perspectives, the politically most convenient way to deal with the sharply growing US debt is to eventually pay it back in devalued dollars. For bonds, the longer term outlook may be even more troubling, as protracted military stresses and a deteriorating demographic profile adds to the fiscal imbalances already in place. That’s why a potent hedge against your dollar and bond holdings, such as gold, should be a cardinal point in your investment strategy. Be careful, however, not to time a dollar and bond decline. The world in which we live is complex and analysts have already demonstrated how wrong they can be in predicting an end to the massive foreign capital inflows that have kept the dollar and bonds solid. But the correction will come: while Japan, China and oil producing nations keep sending surplus money to the US, an ever higher portion of the ownership of America’s debt resides in foreign hands. That will eventually force a substantial dollar devaluation. In short: protecting against the coming correction in the dollar and bonds makes sense, but betting on that event to occur at a given time does not.
More cautious consumers will save more, which may help bonds in the short term. Let me caution you, though: I believe that any strength in the bond market will prove temporary. First of all, current bond yields reflect an expectation of only 1% GDP growth, yet the economy keeps growing at a considerably faster clip. That means that unless the US economy is headed for very low growth or even recession, bond yields could soon be driven higher again. I also don’t like bonds from a medium and longer term viewpoint. The structural impediments to fixed income markets are huge (see my comments in the previous segment), making a protracted bear market in bonds an almost certain long term bet. That’s why I favor locking in high quality bonds with a life of up to five years and staying away from lower-rated issues and longer maturities.
A recent study by UBS quantifies the US debt dilemma. In order to finance its current account deficit, America must attract $1.72 million of foreign capital every minute. At the moment, Japan is the largest holder of US Treasury debt with $640 billion, followed by China ($330 billion), Britain ($175 billion), and oil exporters Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the UAE, Algeria, Gabon, Libya and Nigeria. In looking at this list, I can’t help notice that a significant number of America’s creditors are nations that already are, or may soon be, on a collision course with the US. That’s probably what led the author of the UBS study to conclude that “the days of cheap and reliable financing of the US consumption boom are coming to an end.” Geopolitics, in particular, may upset the one-way flow of capital to the US.
Peter Cavelti’s background as a financial analyst and author spans 35 years and four continents. His grasp of global issues is extraordinary and his comments and books have been published internationally. He was president of Canada’s Guardian Trust and subsequently owned his own firm, which managed some of the best-performing natural resource mutual funds. Peter firmly believes that only an integrated understanding of geopolitical, demographic and economic events can lead to successful investing, and that is what his web service Perspectives is about. If you feel keeping on top of relevant global events takes too much time, Perspectives is for you. Whether it’s investment advice or political analysis, Peter offers his insights in concise and easy-to-read form. Best of all, Perspectives is free. Visit www.cavelti.com and sign up today!