Back where we started

As concern grows for the future of the dollar, we should reinterpret stock movements to take account of currency exchange fluctuations. The above chart shows the Dow since the start of the year (red line) and adjusted for relative value of the US dollar against the Euro (green line).

If you have any suggestions as to what other currency to use instead, I'd be glad to read them. I fear that future weakening of the British pound and the US dollar may well undermine apparent future recoveries on their stock exchanges.

Is now a good time to invest?

I've just been asked by a client whether he should switch from cash to equities. Here's my view, and it may explain why I haven't earned much from investments over the last few years:

It is not possible to predict the market with any accuracy, but I think I have done well in foretelling the current state of affairs as early as the late 1990s. The market has dropped to half its 1999 peak (again, as it did in 2003), but that is not to say we are now at the bottom. Some (and I am moderately persuaded to this view) think that there may be a "bear market rally" soon-ish - maybe a rise that recovers perhaps 50% of the losses so far - but it is perfectly possible that the underlying trend is still downwards, so there may then be a horrid lurch towards - what? Maybe, ultimately, 4,000 on the Dow and 2,000 on the FTSE.

We are in the middle of an exciting ride and I fear that entering the market at this stage may still be for the adventurous and nimble. Yes, had one invested in mid-2003 and got out, say, late 2007, it would have turned a nice profit; but much depends on the entry and exit points. So as ever, attitude to risk and corresponding watchfulness are key factors.

There is also the question of what asset class to choose. I think domestic and commercial property are still overvalued, relative to income; because of fears regarding other assets, and also because of central bank investment ("quantitative easing" etc) government bonds are very highly priced, which is why the yields are so low (and if interest rates rise, bond values could then drop sharply); equities are depressed, but as dividends decline in very testing economic conditions, they may ultimately be depressed still further. Commodities (e.g. gold, silver, oil) are the subject of some speculation, but owing to shortage of borrowed money to invest with, not quite so much institutional speculation as formerly; even so, gold (for instance) is a bit above its long-term inflation-adjusted average, as far as I can tell - though if inflation takes off, the price could indeed escalate.

And then there is the question of currencies. The pound has lost heavily against the dollar; but some say the dollar may catch us up again. The Euro may also not stay as strong as it is now - several countries within the Eurozone are suffering economic problems and are hampered by the common currency; I have even read speculation that the Euro system may fall apart within a decade, or some states may secede from it.

In short, I still urge caution, and if you do decide to get in, be prepared to move quickly if the market should turn. Meantime, there are relatively safe options such as National Savings Certificates, including the index-linked ones that will at least keep the value of your savings roughly in line with RPI...

Wake Up!

Jim Mellon and Al Chalabi, authors of "Wake up!" , have emailed their latest interesting and useful newsletter. It concludes:

Our strongest recommendations are as follows:

• Prepare for rising inflation – continue to buy gold;
• Sell government bonds;
• Look for cheaply valued strong stocks – BAE and BP in the UK are two examples, and in the US we like Pfizer.
• Deploy cash wisely – our current favourites are, believe it or not, the British pound; the yen is weakening, but at 100 yen to the dollar it is a buy again.
• Avoid the US dollar and the Euro.

Like that bit about the pound - I was scratching around looking for something to save what's left of the savings.

Denninger: deflation

Belatedly, I refer you to Karl Denninger's end-year review and forecast. He sees continuing deflation, and makes a number of other plausible and worrisome predictions - scroll to the end of his post for the horrid gallery of prognostications.

In short:

...rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance, get stingy and prudent. Your personal financial survival could well depend on it.

So instead of staring at the low interest on your cash balance, think of the real capital appreciation of your money as measured by what big-ticket items it will buy. And for once, the government can't easily tax your capital gain.

You may also want to hold more cash away from a bank ("Round #2 of severe bank instability gets served up on us in the second half of 2009").

And maybe diversify your currency holdings:

The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are... The rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example... I see the potential for the pound and euro to both reach par with the dollar.

I think Denninger on the one hand, and Faber/Janszen on the other, may both be correct. It's a matter of timing - deflation now, debasement of the currency later. Because nominal debt gets relatively bigger as assets and incomes decline in value, something will have to give.

Every picture tells a story

You've had your warning

Lord Myners has been criticised for telling the truth too early, i.e. 3 months after the general public could have done anything to save themselves. On October 10, "major depositors" in the USA and Japan were preparing to withdraw their money, and were willing to paying any attached penalty to do so.

For the rest of us, the corralito: "The Mail on Sunday has been told that the Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals."

Even if they had caught wind of it, would we have learned anything of this from the mainstream media? (Scornful laughs) But what were MPs doing with their own money? Perhaps they'd have abandoned us to our fate, like Lord Jim. (I have often thought that the main reason for getting into politics is the opportunity to trade - in all sorts of ways - on inside information and networking).

Do you think the banks have been saved? Mish doesn't think so. Is the pound safe? Jim Rogers doesn't think so (though this business associate of the sterling-busting George Soros may be playing a nasty little game of market manipulation - which is, scarcely credibly, not an incarcerable crime but merely a civil offence.)

Within the past 12 months, the pound has gone from USD $2.12 to $1.43 and Euros 1.40 to 1.06; to put it another way, imports now cost 48% more from the States , and 32% more from Europe. (O&A typical cash rates)

At least you can still get your hands on your money; but for how much longer? It may be that the crisis is over; but it may be that we are in the eye of the storm. Personally, after settling debts I intend (a) to draw extra cash, keep the slip to prove it's been legally obtained, and store it safely away from a bank; (b) to keep at least some of my money in foreign currencies - perhaps the Yen* and Euro*; (c) to look for a variety of non-cash stores of value - and not all of them with Government guarantees, either.

My trust in banks, politicians and journalists is broken. My faith in them is gone, because they did not keep faith with me.

*Though The Big Picture thinks Japan will move to weaken the yen and the Euro-zone is struggling to hold its members together. So, US dollars?

Desperate diseases call for desperate remedies

Mervyn King at the Bank of England refers to "unconventional unconventional measures". One seems to be to stop publishing what he's doing; what else can he have in mind?

Brad Setser thinks the pound sterling may crash through the floorboards.

"If you cannot bring good news, then don't bring any."

Gold, silver, what you will... but not sterling

Jim Rogers says exit the pound and sterling-denominated assets. (htp: Wat Tyler)

Relativism

It's hard to measure what's going on, because currencies have turned out to be rulers made out of very stretchy elastic - especially for us Brits, recently.

In this article, Kurt Kasun reproduces a chart from Marc Faber's latest newsletter, showing an estimated drop of c. 50% on the world's stockmarkets - a loss of some $30 trillion.

So I've looked at the Dow and the FTSE, as priced in Euros, since the Euro appears to be more stable than either the dollar or the pound sterling (until we discover the supermassive black hole at the centre of the European financial galaxy, no doubt).

On yer bike

Thus Denninger:

Bernanke clearly thinks ... that he can "restart borrowing." ... This is causing the dollar to get slammed - at least for a little while... These sorts of actions ignite wars. Choose between a trade war (about 75% chance) and a shooting war (the other 25%).

The dollar weakness, by the way, won't last. Either sort of war puts every other nation in the world in worse shape than us, which over time leads to the same place - "we're screwed but they're screwed worse."

He's not wrong. Total US debt, foreign and domestic, has recently been calculated as 392% of GDP; but alas for us Brits, UK external (foreign) debt alone is running at 400%. I just don't know what a like-for-like comparison would show.

The TV news here tried to put a merry gloss on sterling's collapse, reporting how it helps exporters like a bicycle firm they visited. A bit desperate: the start of the 'Oxford Automobile and Cycle Agency’, this isn't. You know you're in trouble when they tell you to "smile, smile, smile."

All in the same boat

Mish notes that because it's a global crash, everyone is printing money and the relative value of the dollar has not plummeted as many expected:

... Looking ahead, it is quite possible that if all pegs were removed and the Renmimbi allowed to freely float, that the Renmimbi, not the US dollar would crash. Certainly the pound could crash (I think that is likely), and the EU might even break up.

How much further can the pound slump?

UK worse than USA?

If it's the USA (aka The Great Santa) that's in dire trouble, how come the pound sterling has dropped 5 cents against the dollar, since July 17?

Should sterling now decline against the US dollar?

Mish thinks so, now we've decided to borrow our way out of a recession.

Also interesting to hear the discussion on Radio 4's Any Questions, where the assertion that Gordon had stuck to the EU's "40% of GDP" borrowing guideline wasn't challenged by anyone, despite the massive off-book PFI financing.

What oil hike?

The Mogambo Guru (too long absent from these pages) points out that a major factor in the increase in the price of oil, is simply the decline in the dollar. We here in the UK don't see it, because the pound is staring the dollar in the eye as both go screaming parachuteless towards the ground.

At least Richard Daughty is one who will not go gentle into that good night.

Now, isn't this what happened in the Seventies? Only we were conned into thinking it was down to wicked Arabs, when really the story was increased monetary inflation for some years pre-1974.

A pound to a penny

Adrian Ash points out that against gold, the British pound is now less than 1% of its value in 1931.

Something's gotta give

Interest on official debt in the USA runs at $430 billion for 2007, and rising steeply, according to the Treasury's own figures (htp Michael Panzner, quoting Mish's Global Economic Trend Analysis); total government debt is now c. $9.2 trillion.

It's more serious than that, of course: James Turk quotes the Comptroller General, David M Walker's estimate that total liabilities, including commitments to future social security benefits, are around $53 trillion. The government's annual revenues are only around 5% of this figure, so the credit card looks like it's pretty much fully-loaded.

However it happens, it seems something must give way under the strain. Frank Barbera reckons the Dow has plenty further to fall (and possible interim correction or not, he thinks gold looks good). Prieur du Plessis concurs, quoting Nouriel Roubini's comment that "... a lousy stock market in 2007 will look good compared to an awful stock market in 2008."

Bob Bronson thinks the downturn will be long as well as hard. He in turn quotes the chairman of the National Bureau of Economic Research: this one “could be deeper and longer than the recessions of the past.”

Boris Sobolev also looks to gold, but prefers the smaller companies because of all the money that's piled into the majors.

In case we in the UK should be tempted by schadenfreude, Ashraf Laidi predicts that sterling will accompany the US dollar's fall against other currencies. From what I read in connection with the USA, a weakening currency may provide a temporary boost to exports, but also inflate the cost of imports; so I don't suppose that our following the dollar will do us much long-term good, either.

Of course, it's possible to dismiss all this as group-think wall-of-worry stuff, but maybe that would be double-bluffing ourselves. Sometimes, things are exactly what they seem. Banks have consistently turned a profit for centuries, on the inexorability of debt.

That sinking feeling

It is now 100 days since July 6, our starting point for measuring the Dow's fall. Against gold, the decline is substantial.

What about currency risk? According to O&A historical figures (using interbank rates), the US dollar has declined against the British pound by only 0.8%; and against the Chinese yuan, only 1.2%. But in the same period, the dollar has lost over 4% against the Euro, and 4.3% against the Japanese yen. Annualised, that's a drop of about 15% per year in yen terms. (Which currency has Warren Buffett bought this year?)

Gold? Acording to the World Gold Council (WGC), in the twelve months to 26 September, the Eurozone has sold 475.75 tonnes. (This zone includes Sweden and Switzerland; the latter has disposed of 113 tonnes out of that total, or nearly 9% of its stock. How strong is the Swiss franc? Is sound money a bad idea?)

The WGC September account reports that the US still holds 8,133.5 tonnes of gold, exactly the same amount as reported for Q1 2005, two and a half years ago. Allegedly: never forget that "credit" is Latin for "he believes it."

But maybe that's so; maybe Uncle Sam has, er, requested that other countries reduce their bullion stock in order to, um, maintain price stability. After all, the dollar has fallen 13.4% against gold already.

The competitive struggle to lose currency value continues.

Inflation, here we come

Jordan Roy-Byrne's article featured in Financial Sense last week examines various types of inflation and gives graphs, facts and his thoughts on future trends. He concludes:

It is my belief that the Fed's recent cut is the wake up call that will finally stimulate rising inflation expectations. Moreover, the public awakening towards inflation is coming at a time when monetary inflation, commodity inflation, currency inflation and wage inflation, already at significant highs, are set to rise even further.

He predicts a sharp acceleration when gold breaches $1,020 per ounce - itself a price level about 38% higher than today.

Although his remarks have most relevance for an American audience, it is worth remembering the recent Telegraph article (5th October) that forecast sterling dropping even faster than the dollar. Our determination to be as financially reckless as our Transatlantic cousins may result in our facing similar problems.

The good news? Our enormous holding of US Treasury stock may turn out to have been a reasonable investment, in sterling terms. The bad news? Perhaps we should have put that money into bonds denominated in a stronger currency. The Euro, maybe?

Which will fall faster: the pound or the dollar?

An article in the Telegraph (referred to by today's Daily Reckoning) says that the pound sterling could drop about 14% against the dollar by 2009.

Which one is the basket case economy?