Ahlgren Multiverse: THE DOLLAR TEETERS ON THE BRINK -- THOUGHTS 1/5/09

"By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens."

-- John Maynard Keynes

For the record, I believe John Maynard Keynes is one of the top-ten most evil human beings ever to have walked the earth, but I am thrilled to see that he at least admitted his theories amount to no more than legalized theft.

In the last few trading days, I've been watching the dollar strengthen, which, if you've been reading my articles, doesn't make a lot of sense -- at least not on the surface. The Fed is creating more currency than ever in history, and that, by definition, is inflationary. Remember what we said yesterday: inflation is not rising prices, inflation is an increase in the amount of currency available. Rising prices result from inflation. So if there are more dollars in the economy right now than ever before in history, shouldn't prices be rising? Further, as long-term Treasury yields increase -- as they have been, dramatically -- doesn't this offer further evidence that interest rates are heading upward?

I think there is a very simple explanation for this, and I think it's a short-term phenomenon. Today, just about every asset-class is down. Gold is being punished -- probably for part of the same reason people are selling Treasuries: the so-called "flight-to-quality" is coming to an end as people realize that maintaining these yields on Treasuries is going to be very hard for the Fed to do, and that a return of about 2.5% for 10 to 30 years just sucks. Again, would you loan money to the government for those kinds of returns? I know I wouldn't, and I don't hear many people saying they would. But somebody was, and I think those "somebodies" are starting to realize just exactly how stupid that trade was. So Treasuries are blowing off, and gold is slipping with them.

And that brings me to why I think the dollar is showing some resilience: as people sell Treasuries, gold, and other assets, they are receiving dollars in exchange. But it's more than that -- as they sell these assets, they are, de facto, buying dollars. This is a smaller version of the same thing that happened as the markets sold off in the fall of 2008; the dollar rallied. And that's why I think this support in the dollar is temporary -- all the more so since Treasuries are not also selling off this time.

Just as investors have started to realize that Treasury yields and prices are unsustainable at these levels, they will soon realize that the dollar is no longer the store of value it once was. With the massive amounts of debt we've piled up, along with the unprecedented number of dollars now printed and floating in the system, I believe public perception of the dollar is about to change. And there may be one more surprise coming that most people aren't anticipating: I think it is very likely that many of the world's largest oil-producing countries may soon considering transacting in euros instead of dollars.

So the euro could be a good place to be, going forward -- at least in the short- to medium-term. One of the euro's strengths is that the European Union doesn't issue debt (at least for now), and so its monetary policy isn't heavily reliant on that component -- the way U.S. monetary policy is. I've mentioned that part of the reason the dollar is almost certainly going to come under tremendous pressure in coming years is that so many foreign governments own its debt. As U.S. solvency issues escalate, these foreign entities will sell much if not all of their Treasury holdings, which will drive interest rates higher, causing yet more price increases in terms of an already inflationary dollar. At least from the debt perspective, the euro doesn't have to worry about that, and so the world may well shift away from the dollar to the euro for its global currency reserve.

For the long-term, however, I think the euro is going to have just as many problems as the dollar, and I don't think its strength is sustainable. Remember the European Union's currency printing presses are in high gear too.

So if you believe the dollar is heading south, where do you put your money? Should you short the dollar? Or should you go long the euro? I don't think so. In fact, I don't think shorting the dollar is a good play at all, despite the fact that the euro may show some resilience in coming months and years. No, I think most currencies in the world are going to lose value as governments print their way out of this mess. Even the Swiss -- traditionally the most fiscally responsible government on earth -- are getting on board. So if all currencies are going to fall simultaneously, what will they be falling in relation to?

The answer to that is simple: commodities. And that's why I believe in gold.

Normally, I would be hyper-bullish on oil at current levels. Adjusted for inflation, oil traditionally trades between $25 and $35 per barrel, but with China and India quickly creating strong middle classes, I think there would be a strong case for a much higher oil price. Unfortunately, yet again, the United States is ruining the party.

The U.S. currently consumes 50% of the world's oil. But if I'm right, and the dollar is going to decline, and the U.S. is going to face massive solvency issues because of its fiscal irresponsibility, then our oil-consumption is about to hit a brick wall -- the effects of which will only be compounded if oil-producing countries begin transacting in euros. Eventually, China and India will undoubtedly make up for any shortfall in U.S. oil-consumption, but it will take some time. In the meantime, I wouldn't be surprised if oil traded below $30 a barrel, over some protracted period of time.

So it is the economic component to oil that causes me to doubt its future as a hedge against inflation. It will be a good investment at some point, if your cost-basis is low enough, but I don't know that it's going to be a great investment.

So, I'll repeat it: gold may be the best bet against current inflation and all the misery it will bring. Silver, from a strictly technical perspective, looks a little more appealing than gold, but when inflation really starts to hand us higher dollar-based prices, I think investor psychology will head toward gold because it is by far perceived as the most stable, long-term store of value in the world -- as it has for thousands of years.

So if higher prices are coming -- which they are -- a world full of dollars is going to be looking for a hedge. If that hedge isn't another currency, or oil, or silver, then what is it? Well, what's left? Will investors trust the debt of any sovereign nation after U.S. Treasuries get crushed? I doubt it.

It will have to be gold.

For full disclosure: I'm short long-term Treasuries through the Proshares Ultrashort 20+ year Treasury ETF (TBT), and I'm long gold through the Proshares Ultralong Gold (UGL).

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