U.S. dollar: to buy or not to buy?

(September 9, 2008) Economic news last Friday confirmed why the U.S. stock market had its biggest down week in five months. Friday’s Non Farm payrolls fell by 84,000 in August, and revisions to prior months added another 58,000 job losses. The increase in the jobless rate sent the Misery Index, which adds unemployment to inflation, to 11.7 percent, the highest level since 1991. The unemployment rate is now at a five-year high of 6.1%.

Do you feel like buying the U.S. dollar? No, of course you don’t. Further, ignoring the recent U.S. dollar rally, can anyone find a fundamental reason to buy dollars? No, in fact it is the reverse. Goldman Sachs placed a sell recommendation on Merrill Lynch stock last week, which is a bit like offering a friend first dance with the lions in the coliseum. They are also on the record suggesting that another bank will have to go under and there is another $17 billion more bad debts on the way.

Add to this concoction the fact that Freddie Mac and Fannie Mae are now owned by the U.S. Treasury. After a review concerning the two, U.S. Treasury Secretary Henry Paulson (previously CEO of Goldman Sachs) decided to take control of the government-sponsored entities. The U.S. treasury will place the two entities in a so-called ‘conservatorship’ and pump capital into the companies.

Consequences of the U.S. government bailing out Freddie Mac, Fannie Mae, Bear Stearns and whoever is next — at a time when inflation is starting to take control of the world economy — is, in our view, the first sign that America is no longer the leader of the financial world. Their actions have consequences that look set to change the way the financial world operates.

To compensate one day, perhaps sooner than people expect, the U.S. government will end up owning all, or virtually all, mortgage backed securities. This will give the banks a fresh start. The consequences of bailing out more mortgage providers and, hence, owning more mortgage backed securities are twofold:

First, it will place pressure on the U.S. dollar. A bail out is tantamount to manipulation. Each time they bail out some boats a few days / weeks later the water fills up another flotilla. The value of the currency bailing them out is losing its store of value.

Second, the problem after (a bailout occurs) that moment rests with the banks. The government requires banks to behave like a bank — that is, borrow and lend money. The irony here is that after what the banks have just been through it is a sure bet that that they will be like bunnies under a spotlight — unable to discern what credit is worthy and what is not.

And, if the government does not bail out the mortgage market? The answer is simple: extrapolate the last six months to the next few years. Stocks will fall, inflation will rise and the U.S. economy will struggle to find its way. Chances are it will also drag down the rest of the world with it. Time to buy the U.S. dollar? No, we will leave that to someone obviously much smarter than us.

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(09/09/08)

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.