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Dollar bashing

How is the US Dollar like, the failed DotCom disaster? Dan Denning explains...

As a child, I remember seeing my dad stand in the door-frame and slowly, in an eerily controlled manner, punch the door frame repeatedly. It impressed me and, I admit, scared me a little too.

But in a big Catholic family of twelve children, there are probably plenty of good reasons to unleash what left-over energy you have on a solid wood door frame, rather than, say, on your youngest child and seventh son (me). We have no idea what the old man was hoping to accomplish. He usually ended up with bruised and bloodied knuckles. But afterwards, he was always a lot more relaxed...

The US Dollar is our proverbial door-frame. We occasionally bash our neural knuckles against the buck, trying to punch through the splintered remains of its abstract existence. We search articles and data to get at what really matters about the greenback and why it demands our attention.

And then we read on a blog somewhere about the sock puppet of and it all begins to make sense.

The Dollar, this blog post suggested (we can't remember where we found it) is like an Internet stock circa 1999. Specifically it's like was one of the last Internet concept stocks to go public before the Internet bubble burst in 2000. Its concept was to sell pet things to pet owners...on the Internet. It was a pretty simple business model, made famous by its sock puppet But some concepts are better left on the drawing board...or back in the sock drawer.

“Why buy pet supplies on line?” the company’s advertisement asked. "Because pets can't drive!" Flush with IPO cash, the company shelled out $1.2 million for an ad during the Super Bowl of 2000. But less than one year later, lost its listing on Nasdaq and the company went out of business.

Once started to unravel, very few investors managed to exit the stock without incurring substantial losses. And here is how Pets.Com of yesteryear is like the US Dollar today: Almost anyone who held a large position in would have been reluctant to be the first to sell.

First of all, by selling, you admit that what you own deserves to be sold. Second, your selling might cause other people to sell, triggering a rush for the exits. Once the absurd spell which induced investors to buy too much of a stupid thing is broken, all hell breaks loose and panicked, undisciplined, disorderly, deeply de-stabilizing selling begins.

If the Dollar is like, the sell-off that's coming is going to make the bust look like a day at Disneyland. Everyone in the world who owns Dollar-denominated assets owns a drawer full of Dollars. In fact, so many individuals, institutions and central banks own Dollars that the “overhang” of frightened sellers could be enormous, if a rapid selloff were to begin for any reason.

What might that reason be? Will the Chinese Central Bank spark a mass exodus from the Dollar? We don’t rule out the possibility.

“The Chinese central bank warned that international holders of US Dollar assets may start to adjust their foreign exchange holdings to reduce risk,” Forbes magazine reports. "If the US current account deficit growth continues to be higher than GDP growth, the investment value of US assets will be questioned by global investors, and the willingness of investors to continue holding and buying US financial products may weaken, the central bank said.’”

The Chinese own a lot of Dollars. And perhaps that fact is beginning to make them nervous, as nervous as a long-tailed cat in a room full of rocking chairs, as the Southern saying goes. "China has been cautious in its statements about the Dollar,” Forbes continues. “It now has over one trillion Dollars in foreign exchange reserves, the world's biggest, and about 70% of that is believed to be held in Dollar-denominated assets."

The Chinese have every reason, therefore, to avoid causing a Dollar panic. But in today's Moscow Times comes a sober analysis of what we may witness in 2007. A political crisis in China could spell the end of the Dollar, muses Alexei Bayer, "So far, China has avoided the kind of financial crises and political upheavals that have repeatedly blindsided smaller exporting nations around the Pacific Rim over the past two decades. The Beijing government has used carrots and sticks to keep its vast and rapidly changing society quiescent.

“Past success, however, does not mean that China will be able to keep the lid on this cauldron forever. Economic growth has unleashed tremendous energy and creativity in the Chinese population. But it has also created severe pressures – social, political, economic and demographic. Hundreds of millions of peasants have abandoned their centuries-old way of life and migrated to urban centers. The gap between the rich and the poor has widened...These pressures – or other problems that cannot be currently predicted – could plunge China into a crisis that could be quite severe.

“China has emerged as probably the only nation in the world that can single-handedly undermine the US economy,” Bayer continues. “If China suffers an economic or political crisis, the United States will likely be plunged into a severe recession -- if not an outright depression.

“This scenario is ominously similar to that of the Great Depression of the 1930s, which was largely a US crisis taking place after a decade of breakneck economic growth,” Bayer concludes. “The stock market crash occurred on Wall Street, but its shockwaves promptly spread around the world. Ultimately, the Depression marked the demise of British economic dominance and the end of the pound as a global currency. While the next global economic crisis is likely to originate in China, it will almost certainly mark the end of the Dollar as the linchpin of the global financial system and a substantial diminution of the central role of the United States.”

So far, very few investors dare – or bother – to imagine the dire consequences of a forced Chinese Dollar liquidation, and what it might mean for stocks (very bad) and for gold (very good). But according to a recent New York Times article, the wisdom of individual investors is beginning to trickle up to the boardrooms of the world's central banks.

“Central banks will eventually take the same cue...if they continue to see the value of their Dollar-denominated reserves plummet,” says Professor Richard Portes, who teaches economics at the London School of Business. “People say central banks don't care if they lose money. That's just not true. I've talked to central bankers who have said, 'I'm not going to be the last one out of this room if a fire breaks out.’”

No one wanted to be the last one out of either. But the biggest problem wasn't deciding when to get out. The problem was being “in” in the first place. Such is the problem for today's Dollar-based financial world. And the bigger problem is that there really is no "out" in the sense of escaping Dollar risk entirely. Gold, presumably, would rally as the Dollar’s value tumbled. But most other financial assets would tumble right along with the Dollar. Neither stocks, nor bonds, nor even foreign currencies would offer certain protection against a Dollar debacle. Almost certainly, a Dollar debacle would become a worldwide financial market debacle.

Buying gold sometimes feels like smashing knuckles into a door – it’s painful and counter-productive. But this is not one of those times. As 2007 unfolds, we expect to find the world’s Dollar-holders wincing in pain, not the owners of gold.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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