Time to get out of dollar

What the Fed is doing simply worries me. The Fed’s job is to provide liquidity to the banking system, the oil to engine if you will. That’s fine as long as the banks who need loan put up some risk free asset like treasuries for collateral. What they’re doing now is basically accepting any kind of crap, which investors and regulators have no idea how to price, as collateral. I’d like to see my local pawnshop run like that.

Bear Stern got what basically a margin call and couldn’t cough up the extra capital. Lehman and AIG got into the same trap when their asset went down in value. The GSEs were under capitalized and regulators not only let them, but encouraged them to dig a deeper hole. What did capital hill and the Feb do to save the day? They let election year politics clouded their judgement and quick-fix-smoke-and-mirror took precedent. Now the Fed has God knows how much non-performing assets in its book and Treasury is on the hook for huge potential loss.

The US government owns so much money, the jokes aren’t even funny anymore. The Treasury department has been running a deficit for years, and there will be no surplus for the foreseeable future. Year 2008 tax revenue outlook is not encouraging. So we own a lot of money, we make less money than we spend, we’re getting a pay cut the coming years…you know how the story ends. Since we have no surplus to pay down principle, and our national debt’s interest obligation is only met by issuing more new debt; we are paying interests on interest or compound interest. That’s pretty bad, right? Yeah, it is very bad. But even with that, I was bullish on the dollar vs. euro or sterling since May when the dollar depreciated too much against all major currencies.

With recent events, my view has changed. The US government is now on the hook to own a very big sum of CDO, MBS and mortgages Fannie and Feddie couldn’t buy. These fixed-income instruments generates income stream. As long as the cash generated from interest payment is attractive, these securities will trade at high price and the US government balance sheet looks good. There are many factors affecting the attractiveness/price of these securities. The fall of financial institutions holding these securities doesn’t give me a lot of confident regarding to our ability to accurately price these kind of securities. Who would have known house price falling 15% can cause some securities backed by mortgages to trade 20 cents on the dollar? I’m pretty sure the current price is wrong and correction is going to come when the smoke is cleared and dust is settled. The question is which way the correction is going to go?

In order for Dollar to be strong, the Fed must have the will and ability to raise rate. It looks like the Feb has neither. Tax revenue is heading to a decline due partly to stock market crash, slowing economy, and we won’t see tax coming from those trouble financial institutions anytime soon. With election year politics, you won’t see any spending cut. That left only one option: borrow money. When borrowing money, the interest rate is directly related to some benchmark such as LIBOR or the Fed rate. When the Treasury issue bond, it may pay very little spread over the Fed rate if the market has huge appetite for risk-fee treasury bonds. But you won’t see a lot of buyers when the treasury bond pay less than the Fed rate. That tied the Fed’s hands; in order to borrow cheap money, they can’t raise rate without printing money.

Is there any chance the dollar may go up? Strangely, yes. If the so call toxic securities the Fed took off trouble bank’s books turned out to be pears not lemons, the Fed may end up making a huge profit. I’m not holding my breath for that. The more realistic scenario is the US economy recovers faster than expected. Until that happens, USD is a sell for me.

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One Response

  1. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.

    Tim Ramsey

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