“An Emerging Dearth of Dollars”

Posted On Dec 9, 2016 By Dave Gonigam

  • Mainstream wakes up to the great dollar shortage…
  • But the Federal Reserve is still sound asleep
  • Rickards on how long the dollar can stay so strong (and gold so weak)
  • Coming to a location near you: Dallas pension fund falls victim to “the 8% illusion”
  • Did we really quote out of context?… why the FICA tax has an earnings cap… The 5 chided for not furnishing an echo chamber… and more!

Uh-oh: The mainstream is starting to fret about the great dollar shortage.

With the help of Jim Rickards, we’ve been delving into the paradox of a “dollar shortage” periodically since September. The paradox is this: While the Federal Reserve blew up its balance sheet by $3.4 trillion between 2008–2015, “the world created new dollar-denominated debt faster than the Fed created money,” as Jim explains it. Indeed, more than $60 trillion of new dollar-denominated debt came into existence during this time.

It’s all good… as long as the dollar is weak. But relative to a large basket of foreign currencies, the dollar is approaching its strongest level at any time in the last two decades…

Strong Dollar

“When the dollar goes up, it directly impairs the risk-taking capacities of banks and investors alike,” writes Hyun Song Shin, chief of research at the Bank for International Settlements.

As you might know, the BIS is the “central bank for central banks.” Jim Rickards says unlike many central bankers, the BIS folks are pretty sharp cookies. Mr. Shin, according to The New York Times, “is concerned the dollar’s rise will worsen what he refers to as an emerging dearth of dollars, which could bring back memories of the financial crisis in 2008 and 2009. Back then, a global rush into dollars caused short-term borrowing rates to skyrocket, forcing hedge funds to shut down and banks to fail.”

The dollar shortage is even getting the attention of mainstream strategists like Paul Christopher at Wells Fargo Advisors: “In the type of global economy we live in, [Federal Reserve chair Janet Yellen] has to be careful about the dollar increasing too much, creating dollar shortages and liquidity problems as a result.”

Alas, Fed leadership is clueless. Quelle surprise. And so they plow ahead with plans to raise its benchmark fed funds rate next Wednesday — which will have the effect of further strengthening the dollar.

As we pointed out last month, Fed Vice Chair Stanley Fischer said he was “reasonably confident” foreign economies could absorb the impact of that move: The dollar would strengthen further, yes, but it wouldn’t necessarily tank the value of foreign currencies.

Jim Rickards called this “wishful thinking.”

Let’s go back to that $60 trillion of dollar-denominated debt that’s come into being since 2009. As Jim’s pointed out for the last two years, about $9 trillion of that total was issued by companies in emerging markets; those companies need a weak dollar to keep the cost of servicing that debt from spiraling out of control. But the dollar’s been rising relentlessly since mid-2014.

Also on shaky ground is $5 trillion in debt issued by U.S. energy producers. It was bad enough most of that debt was issued on the assumption of $80-plus oil prices into perpetuity. (They’re $51.45 this morning.) But this is worse: “A strong dollar implies lower oil prices,” Jim reminds us, “despite OPEC’s machinations.”

Reminder: A strong dollar is the only reason gold is so weak right now. The bid is down to $1,161 this morning, retesting a 10-month low.

“A strong dollar implies a lower dollar price for gold,” says Jim. “A weak dollar implies a higher dollar price for gold.” Look no further than the chart above. The dollar’s all-time low came in August 2011. Gold touched its all-time high within a matter of weeks.

“Further evidence,” says Jim, “comes from the fact that gold is performing much better when measured in Japanese yen, Chinese yuan and euros. In other words, the recent price action is not really a gold story; it’s a dollar story.”

Not that it makes gold’s recent swoon easier to take if you transact mostly in dollars, but that’s the story.

“In the short run (one–three months) the strong dollar, weak gold story may continue,” Jim allows.

“Beyond that, the strong dollar will strangle the U.S. economy with imported deflation and weaker exports.” Oh, and it’ll worsen the great dollar shortage and threaten to detonate a large portion of that $60 trillion in dollar-denominated debt we mentioned.

Then the Fed will have to reverse course. Jim figures by next spring. Gold holders, keep the faith. “Gold is in the doldrums now, but it is poised for a strong comeback when central bankers confront the unsustainable reality of higher real rates on dollar debt.”

[Ed. note: In the meantime, the looming Fed meeting next Wednesday has opened the window for what Jim calls “the Trump trade.” Maximum profit potential: 300% over the next 30–60 days. For details, look here. No long video to watch, we promise.]

However today’s trading winds up, the major U.S. stock indexes will have booked huge weekly gains.

At last check, the Dow is up another quarter percent, at 19,661. That’s nearly 500 points since Monday morning.

Not only is gold selling off again, so are Treasuries. Falling prices mean rising yields, and the yield on a 10-year note is up to 2.42%. (It was 1.37% just five months ago.)

No economic numbers of note today; the Street chatter is about yet another Goldman Sachs man joining Team Trump. GS President Gary Cohn won’t get the job of budget chief as originally rumored. Instead, he’s been named director of the National Economic Council — which (we had to look this up) is not the same body as the Council of Economic Advisers. Oy…

[It’s at times like this we’re reminded of historian George H. Smith’s account that upon assuming the presidency in 1801, Thomas Jefferson was appalled to discover the War Department workforce had swelled under his predecessor John Adams — to 13 civilian employees.]

Back to the strong dollar — and another unfortunate side effect.

Granted, “a strong dollar definitely has its benefits,” says our income specialist Zach Scheidt.

“If you take a vacation outside the U.S., your budget will likely go much further. For the same price that you might have paid a year ago, you can now stay in nicer hotels, eat at fancier restaurants and bring back more souvenirs for friends and family.

“A stronger dollar also makes imports cheaper. So this may be a great time to buy that Japanese or German luxury sedan.”

But on the other hand… “Companies that sell products outside the U.S. face significant challenges,” Zach says.

“A strong dollar makes U.S. goods more expensive to overseas customers. And when our companies generate profits in euros, pounds or yen, those profits then translate into fewer U.S. dollars.

“Currency changes can be a subtle factor that many investors overlook,” Zach goes on. “It’s much more exciting to talk about the new drug that a company is developing or a new market it is entering.

“But these subtle currency issues can have a big effect on profits. And that’s why I always keep an eye on currency trends — and occasionally suggest that you take action to capture profits or protect yourself from danger.”

With that in mind, Zach recently pruned three positions from the Lifetime Income Report portfolio. For those companies, a rising dollar means dividend increases will be paltry… and dividend cuts can’t be ruled out. But Zach still sees a fertile field of income-paying possibilities out there.

From the “canary in the coal mine” department, we have the police pension fund in Dallas.

From The Dallas Morning News: “The Dallas Police and Fire Pension System’s Board of Trustees suspended lump-sum withdrawals from the pension fund Thursday, staving off a possible restraining order and stopping $154 million in withdrawal requests.”

That was an alarming figure, considering the fund has only about $729 million in liquid assets, and it needs to keep about $600 million on hand at any given time.

Seems the fund’s managers fell victim to something that back in 2010 we labeled “the 8% illusion” — an assumption by government pensions that because they’d gotten average 8% annual returns for the last 25 years, they’d get average 8% annual returns for another 25.

That hasn’t worked out in the years since — not with the Fed keeping interest rates at record-low levels. The fixed-income investments that make up a big portion of most pensions just can’t generate the necessary returns.

If this is happening in Dallas — where the economy is relatively strong and tax receipts presumably robust — we can only imagine what’s in store elsewhere.

As we said back in July, state and local government pensions now have a $4.3 trillion funding shortfall. Watch out for tax increases — or, to use a favorite expression of ours a few years ago, “new taxes and weird fees.”

“You quote the general out of context,” a reader writes after we mentioned Trump’s pick for secretary of defense, James Mattis, is a Russia hawk.

“He was really talking about the downsizing of defense capabilities in the face of massive

Russian investment in theirs. In other words, we have foolishly abandoned our ‘peace through strength’ policy. I agree.”

The 5: Hey, you’d be a pretty good defense-industry lobbyist.

In reality, six weeks ago, the Financial Times reported that a draft budget proposal in Moscow had a 27% cut to defense spending next year.

And even before that was announced, Moscow’s military expenditure amounted to one-ninth of Washington’s…

Billions for Defense

Heck, going by that Pentagon study that the Pentagon buried because it was too embarrassing, Moscow’s military budget is half that of the waste in Washington’s!

And Mattis’ speech went beyond mere comparisons of capabilities: “Putin goes to bed at night knowing he can break all the rules and the West will try to follow the rules,” he said in that Heritage Foundation speech. “That is a very dangerous dichotomy in the way the world is.”

That doesn’t sound much different from the Russia-bashing we’ve heard both before and after the election…

“I have said, since its inception, that the motto of Obamacare should be ‘Solving the Social Security problem, one patient at a time,’” a reader writes after we noted yesterday that U.S. life expectancy is falling and more people are dying in middle age.

Hmmm… We’re loath to pin the entire blame for rising death rates on Obamacare. But we’ll gladly pin it on general government meddling in health care. We mentioned just one example in passing yesterday: The government’s 35-year war on saturated fat has, ironically, contributed to record levels of obesity, and obesity appears to be what’s driving higher death rates from heart disease.

“Why does the government have a limit on wages to pay toward Social Security?” writes a self-described longtime reader.

“If a person makes a million or more, or any wage, why not pay into Social Security? l have never understood why we have a limit on wages that pay into Social Security. Please let me know, if you can, why there is a limit and can it be done away with. Thanks, and keep up your great work.”

The 5: The taxable earnings cap — which rises from $118,500 this year to $127,200 next year, by the way — helps maintain the fiction that Social Security is a “social insurance” scheme. Take away the cap and it starts looking more like a straight-up wealth transfer.

That’s not to say the cap won’t go away at some point. We’d bet it will… and probably before the politicos get serious about “means-testing” Social Security benefits. After all, lifting the cap would hurt current workers, while means testing would hurt current retirees. And it’s seniors who vote in the largest numbers…

“Wait. Back the truck up,” writes a reader after we addressed the matter of conflicting views among the Agora Financial editors. We said, ‘If we all lived exclusively in our own ideological bubbles, the world would be a lot more boring…’

“What kind of fake news site are you running?” our reader objects, tongue firmly in cheek. “I’m looking for an echo chamber to confirm my beliefs.

“If you expose me to new ideas that force me to reexamine my beliefs, how am I supposed to feel superior to others who think differently? I expected better from The 5 than the acknowledgement that differing views exist.”

The 5: OK, good enough then. We’ve always been at war with Eastasia. How’s that?

Have a good weekend,

Dave Gonigam
The 5 Min. Forecast

P.S. As long as the subject of Social Security came up again today…

Buried deep within Social Security’s website is an investment “loophole” that every American senior can take advantage of to secure anywhere from $400–4,700 in additional monthly income.

The best part: Congress is powerless to stop it.

Click here to find out more.


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