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Posted 12/8/2003
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Dollars dramatic decline comes out of your wallet
Too many people believe the dollars decline over the last year is helping the economy. In fact, its an increase in the cost of living, and the increase keeps getting bigger.
By Bill Fleckenstein
As we head into winter, it's impossible not to notice a drop in the temperature. As our country heads into a potential currency crisis, however, most folks have ignored the drop in our dollar. That complacency ultimately will cost us, when abruptly, the dollar's decline begins to matter.
I have been saying all year that the dollar was headed for rough sledding. And I thought most folks, unaware of how these macro variables affect everything, would act as though a decline in our currency was actually good news. It is not good news.
A de facto increase in the cost of living
Those bullish on stocks because of the dollar's weakness have not understood the reason behind its smashing in the first place. So, they can't envision the decline getting out of control.
The currency market is the ultimate outlet where votes are cast against a central bank that is acting foolishly. Thanks to the actions of our central bank in the last few years, we have seen a dramatic decline in the dollar. Its not been portrayed as such. In fact, it has been deemed to be orderly and has many people trumpeting how good it is. (Compare the carnival barkers at the Fed to their responsible counterparts in Australia. Last week, these real men from Oz raised the overnight lending rate 25 basis points, to 5.25%, as a pre-emptive move against the speculative fantasies that give rise to a mania.)
Let's call a spade a spade. When the value of your currency goes down, it is bad, plain and simple. It is a de facto increase in the cost of living -- your cost of living.
Lower-dollar bulls hit an oil slick
Last week, OPEC provided a timely example of why. Now of course, we really don't have to pay attention to anything that OPEC does, because oil is something that we don't use much of, and energy doesn't really enter into our daily lives in many different ways. It's so unimportant that, just like food, we get to exclude it from the so-called "core CPI." So, the CPI is down to some hedonically adjusted core number that doesn't include two things you can't live without, i.e., food and energy.
But all of that aside, consider this from Bloomberg News last week: "Saudi Arabian Oil Minister Ali al-Nuaimi said a weakening U.S. dollar justifies higher oil prices, adding an OPEC production cut in the first quarter was 'highly likely.'"
OPEC, which is holding its production levels for now, has seen its revenues shrink in non-dollar terms and is contemplating a price hike, which would be a de facto transfer of money from us to them. It is unarguably not good news, and it provides a quick demonstration of what happens when your currency goes down.
If its not made in the U.S., it will cost more
Its not just oil that will affect us. Everything we want to use that is not produced solely in America can and most likely will cost more. Of course, the irresponsible policies on the part of the Federal Reserve that have led to the lower currency also have caused lots of other creeping costs, as anyone who pays bills on a regular basis knows. Price increases show up in lots of strange places, but that is the net result of irresponsible money printing.
Thus far, we have not hit the "out of control" part of the decline, but the situation continues to get dicier. As I noted in my daily column about a month ago, even Warren Buffett has publicly stated that he is on board with this idea. He has by his own admission never traded currencies in the past, even at such obvious junctures as the Plaza Accord of 1985. That was the big meeting in which then-Fed Chairman Paul Volcker and former Treasury Secretary James Baker convinced European allies to lower the value of the dollar. So the direness of our present situation must appear that much greater.
One of these days, the dollar is going to be a problem for the world. Its decline will turn into a rout, and all of the negative consequences will be dealt with in short order.
When will that happen? I don't know, because it's as much a psychological phenomenon as it is an arithmetic one. But I do know that when a dollar rout does occur, there will be no non-chaotic or painless way out. (For review, please see my previous columns: "Face up to the falling dollar," June 2; "Fantasy, the Fed and the falling dollar: Oh my!," May 12; and "The dollar is on borrowed time," May 5.)
Regular readers probably have some exposure to foreign currencies and/or precious metals, which will help ameliorate the damage. (For review, please see my Sept. 29 column, "Making the case to own gold.") For folks considering a position in gold, the London-based exchange-traded fund for gold is scheduled to debut this coming Tuesday. There also will be a domestic ETF for gold, but its launch has not yet been announced.
Yellow dog morphs into yellow stallion
Gold, I would just note, recently demonstrated the most impressive display of strength in as long as I can remember. Early last Monday, gold traded as high as $402.50 an ounce, up $4.50, before a slide in the euro pulled it back under $400. Briefly negative on the day, gold nevertheless managed to turn around, grind higher and finish on the high tick -- even while the euro stayed red and stocks continued to move higher. Despite faltering at a level deemed to be important, gold basically went up on its own.
In times gone by, it would have been crushed on the back of such a sell-off as initially seemed to unfold. But not only was the sell-off short lived, gold closed, to repeat, on the highs of the day. It was almost as though gold had finally said: OK boys, I'm not moving just in response to some other thing like stocks and the euro. I am my own man, I'm the strongest currency in the world, and you'd better pay heed to that.
I don't want to make too much of one day's action, but it truly was impressive to watch the spectacle of gold shake off the yoke of being some erstwhile also-ran and charge to the fore as leader of the currency market.
Playing with fire
Returning to stock land, we are in the time of year when folks are expecting a Santa Claus rally. (This is not to be confused with the New Year's rally, the spring rally, the Memorial Day rally, the summer rally, the Labor Day rally, the Thanksgiving Week rally, the year-end rally, or any of the other rallies that are supposed to occur on Wall Street each year.)
With froth capping the current mood, I'm sure it's very tempting for folks to play a little bit from the long side. (I myself am not short). But anyone who is long equities in any kind of serious way definitely is playing with fire. Especially when you add in our external debt position and what's going on with the dollar, it's very difficult to see how this party can have a happy ending.
Investment management vs. investment marketing:
Finally, a Wall Street Journal article, "A fight at Invesco spotlights the toll of market timers, brings me to some personal reflections about the investment-management industry. First, let me offer some thoughts on the long side of the business. In the old days, you had to do the best job you possibly could because it was your investment strategy, and your performance brought you clients. I left the long side back in 1996 because I did not like where the industry was headed. For going on seven or eight years now, my view has been and continues to be that the investment management business has devolved into the investment marketing business.
The Journal article chronicled the losing battle between shareholder-first portfolio managers and the powers that be that sought growth at all costs. One former Invesco manager told the paper: "You had to carry more cash because you knew you had hot money . . . I knew it would disappear. . . . Market timing is not good for long-term shareholders." In detailing many of the frictional and performance costs of handling that hot-timing money, the article made it clear that Invesco's goal was growth at all costs (which naturally brought fees to the bottom line), rather than trying to do the best possible job for its shareholders.
These conflicts of interest were, of course, covered up by our mania and investor naivet, but all that will change eventually. As the bear market reasserts itself, the investment industry will see a dramatic skinnying down. For the time being, folks who intend to hand their money off to "professionals" should first do some serious homework on just who is waiting with open arms at the receiving end.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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