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The Slow Demise of the Almighty U.S. Dollar

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Even when you think you're sitting still, you're not. We may not feel a thing, but each of us is actually hurling through space at astonishing speeds as our planet rotates on its axis. While performing these daily high-speed pirouettes, moreover, our collective home simultaneously rips through the firmament at roughly 67,000 miles per hour in its orbit around the Sun. Relative to the Earth, of course, our velocity can indeed be zero.

I point this out to remind us all that: (1) Relative measures can be tricky business, (2) perception can certainly blind us to reality, and (3) stepping outside one's customary frame of reference can reveal important hidden truths. Each of these lessons will now prove useful as we examine the tenuous fundamental condition of the world's dominant reserve currency: the U.S. dollar.

Understand what you're measuring
It's easy to get caught up in the game of assessing the value of fiat currencies solely in relation to each other, but within the context of the global currency crisis we presently face, I urge investors to carefully consider the limitations of a relative measure. But that's not to say the relative measure is insignificant.

The recent rally in the U.S. dollar index does indeed illuminate some important dynamics within the currency world. As unattractive as U.S. Treasury bonds may be at today's historically low yields, appetite for euro currency exposure appears lower still as the ferocity of Europe's meltdown brings the very survivability of the currency into question. The outlook for further structural impairment of the euro is set in stone as Spain grasps for a handout and Italy braces for its own inevitable moment in the crosshairs. Just last week, the European Central Bank diluted its balance sheet by accepting weaker forms of collateral to include asset-backed securities relating to auto loans, small-business loans, and mortgages (commercial and residential).

Because the dollar index measures the greenback against a weighted basket of currencies, with the euro accounting for 57.6% of that basket, it goes without saying that a crisis-driven exodus from the euro will make the dollar appear strong by comparison. Together with the British pound and Japanese yen, these top three weightings in the dollar index account for 83.1% of the dollar's relative valuation!

Perception and reality are not necessarily linked
On a fundamental level, the current rally in the dollar index belies a still-deteriorating structural condition of the dollar; just as the perception that we can stand completely still here on Earth masks the underlying truth of our perpetual high-speed movement through space. If all the major fiat currencies were to suffer devaluation in tandem, it's conceivable that a relative measure like the dollar index would register no movement even as the purchasing power of each suffered a meaningful decline.

As I pointed out here, the International Monetary Fund has urged both Japan and England to engage in additional stimulus as the severity of Europe's crisis and unsettling weakness in Asia and the United States weigh upon global forecasts. Bank of England Gov. Mervyn King vied this month for a $78 billion expansion of its asset-purchase program (to $586 billion), and HSBC Holdings sees King's minority position gaining the majority next month. A pair of easing-friendly appointments to the Bank of Japan's board last week eases the way toward a potential boost of Japan's $500 billion asset-purchase program. If they were each to join Europe's ongoing monetary blitz, and the Federal Reserve stood pat with only Operation (re-)Twist, we could certainly see this dollar rally gather additional strength in the near term.

I consider it more likely, however, that all four of these key central banks may embark upon a coordinated, roughly simultaneous money-printing event in a high-stakes attempt to diffuse the global debt crisis and reverse the current tide of weakening economic growth outlooks. Jan Hatzius, chief U.S. economist at Goldman Sachs (NYSE: GS  ) , commented last week that "an extension of Operation Twist could well be insufficient on its own and could thus be followed by additional easing action before long." Given the anemic condition of domestic economic activity, the U.S. can ill-afford to see its currency make gains against the major world currencies, and thus we find ourselves embroiled in this global vicious circle of competitive currency devaluation. As world powers take on increasingly untenable levels of debt in in reacting to the crisis, furthermore, such a continuum of collective devaluation becomes the only viable means of avoiding explicit default with a more cunning form of default.

It would be a mistake, then, to interpret recent strength in the U.S. dollar index as an indication of fundamental strength. Further currency devaluation is on the near-term horizon. The national debt has surged by 44% since I called attention to "The Mother of All Currency Crises" back in 2009. The world continues to move toward a diminished reliance upon the U.S. dollar for trade, as reflected in the 1.6 trillion yuan ($251 billion) exchanged between China and 16 participating nations over the past three years. Vincent Reinhart, Hatzius' counterpart at Morgan Stanley (NYSE: MS  ) and former director of the Federal Reserve's Division of Monetary Affairs, recently downgraded his U.S. growth forecast to 2% for 2012 and 1.7% for 2013. Citing intensification of Europe's crisis and the fiscal cliff looming on the domestic front, Reinhart observed: "a significant tightening in US financial conditions over the past few months."

Stepping outside the fiat box
We have established above that a rally in the U.S. dollar index says little about the fundamental condition of the currency, given the current context in which all the major fiat currencies are subject to deliberate and even competitive devaluation in response to the global debt crisis and resulting currency crisis. A relative value measure can offer a cloudy perception of reality when each of the relative measures is wrapped together in a state of perpetual motion that goes largely unperceived.

To observe that motion from a fundamental perspective, we require a currency that is immune to the ravages of "intentional debasement or counterparty risk." Fortunately, we have gold to fulfill this important role. In 2010, former Federal Reserve Chairman Alan Greenspan stated: "Fiat money has no place to go, but gold ... gold is the canary in the coal mine. It signals problems with respect to currency markets." Where relative valuation metrics fail to paint an accurate portrait of the condition of fiat currencies, gold serves as the ultimate barometer. As investors the world over awaken to the fact that a persistent global debt crisis paired with competitive devaluation of fiat currencies leaves none of the affected currencies as viable safe havens, the world will increasingly look to gold (and silver) as the ultimate safe have asset. Because competitive currency debasement still has far further to run, so too does gold. It's truly that simple.

More than four years have passed since I urged Fools to "Dodge the Dollar With a Silver Bullet," and notwithstanding the current weakness associated with the dollar's temporary rally, the reasons to seek exposure to precious metals as protection from global debt distress and systemic currency devaluation have accumulated in spades. I encourage investors to view the deep-bargain valuations presently pervading the mining stocks in as a golden opportunity to gain a foothold in gold. Now near $8 per share, I believe the market has accorded shockingly little value to AuRico Gold's (NYSE: AUQ  ) nascent Young-Davidson mine in Ontario. Another long-standing favorite among the mid-tier gold producers, Eldorado Gold (NYSE: EGO  ) looks favorably poised to continue delivering peer-leading production growth for years to come.

On the silver side, it's difficult to fathom how Silver Wheaton (NYSE: SLW  ) could fail to deliver meaningful appreciation as the fiat currency devaluation trend marches steadily forward. Silver Wheaton was among my earliest CAPScalls back in 2006, and I think the stock could quadruple from present levels before this currency crisis is done. To track all of my coverage of gold and silver, and the macroeconomic factors driving my bullish outlook for the metals, please bookmark my article list or follow me on Twitter. And if you have thoughts about the fundamental outlook for the U.S. dollar and other impaired fiat currencies, please sound off in the comments section below.

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Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of AuRico Gold, Eldorado Gold, and Silver Wheaton. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (34)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 27, 2012, at 8:24 PM, EGTalbot wrote:

    I don't disagree with anything you've written here, but I think it's important to be realistic about the perception of the dollar. The recent strength IMO has been a flight to safety. Yes, I know the idea of the dollar being safe is laughable, but that's still how people are perceiving it.

    Investing in PMs as protection against the coming devaluation makes sense to me. However, it would not shock me at all to see the dollar higher and gold lower (in dollar terms) a year from now. When the Euro goes down, the dollar and treasuries will soar. Ultimately it comes to timeframe - you noted that more near term strength is possible. The dollar could hang on for several more years, and that shouldn't shock anyone.

    I tend to think that the volatility of the past 12 months in the PMs reflects (among other things) the fact that newcomers to PMs - those who helped things really pick up steam in 2010 and into 2011 - are uncertain. They jumped on a bandwagon without fully understanding that the fact of a massive increase in money supply did not have to mean an imminent crash in the dollar and rise in PMs.

    I do not claim to know how this will shake out, but my gut says that short of something military shaking things up, we're a number of years away from the really traumatic stuff that will cause PMs to soar. The fundamentals say it has to happen, but they don't say when.

  • Report this Comment On June 27, 2012, at 8:53 PM, XMFSinchiruna wrote:


    Substantial monetary easing is coming from the Federal Reserve, very likely in multiple tranches over the course of several years, and this will generate a meaningful boost for gold beginning far sooner, by my estimation, than the timeframe you allude to above.

    Recall that a surging USDX (relative measure) corresponds to meaningful headwinds against an already troubling domestic growth outlook, thereby increasing the FED's incentive to pursue devaluation roughly in lock-step with other key central banks. We have seen Switzerland, as a prime example, stop at nothing to prevent its currency from playing the safe haven role. It's a global race to debase, and ultimately a common policy of cunning sovereign debt default.

  • Report this Comment On June 27, 2012, at 9:44 PM, EGTalbot wrote:

    Agreed. But if the Fed only devalues the same as everyone else, the dollar will likely go up relative to everyone else (and gold will not rise tremendously in dollar terms), because of the perception of the dollar as the strongest.

    Ultimately it comes down to waiting until a critical mass recognizes that no fiat currency is actually safe. The first half of 2012 suggests that we're a bit away from that critical mass. Is it six months or six years? I don't know, but it would be foolish, not Foolish, to assume one or the other, given how much is dependent on perception as opposed to reality.

    On a side note, let me offer heartfelt thanks for all the great research and info you post on the PMs. It is invaluable and much appreciated.

  • Report this Comment On June 27, 2012, at 10:29 PM, XMFSinchiruna wrote:


    In a coordinated easing scenario, you can bet your bottom dollar that gold will surge aggressively against each offending currency.

    Thanks as always for sharing your well-reasoned perspective, and for the kind words above.

  • Report this Comment On June 28, 2012, at 2:41 AM, hdotmom wrote:

    As I continue to invest in gold and silver it becomes increasing difficult to tell my better half not to worry that I am doing the right thing. I haven't read much lately about other stocks but the Motley Fool writes like there is no end to this madness. I dropped the newsletter I paid for because there was never a mention of the speed the world is turning. It just made no sense to me. The only time I hear about gold going up is here or AM radio. Almost all of the people in my life think everything is just fine. They believe there will be jobs and everything will get back to the way it was. As for the country's debt they just can't comprehend it so they ignore it. The way I see it is that we will have to go into hyperinflation so we can pay back our debt in valueless dollars. My worry then is that the countries we owe will be pretty darn angry and what will that bring? What kind of shape will we be in as a nation to defend ourselves?

    I have a daughter in engineering school and one that will enter college this year. I also have a son with autism. It is hard to think about what their world is going to be like. But we just go on living day to day like everything is just peachy. Sometimes I feel like going out and just borrowing every dime they will let me have and living it up as my debt will be wiped out in hyperinflation just like the governments.

  • Report this Comment On June 28, 2012, at 10:36 AM, XMFSinchiruna wrote:

    PIMICO's Bill Gross: U.S. Treasuries are a safe haven for now, but nor forever.

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