Marketview – Reserve Currencies

Aug 11, 2015 | Blogs

Terry Sawchuk
Founder & Chairman

The Markets

Volatility is back.  Since our last newsletter, the market has really been active in both directions, but clearly more down than up.  This is where we earn our keep.  The fact is, nobody knows how things will play out, but we have tools to help us navigate these types of situations.  Since the market bottomed in March of 2009, we have been down this road a few times, where the markets start to crack and there are signs of imminent doom, only to watch it swiftly bounce back.  We aren’t saying that’s what will happen this time, but it has happened every time before this since 2009.  The algorithm is doing exactly what it is supposed to do.  Since we have been using it dating back to 2013, it has not generated a sell signal, keeping us in for every bounce back.  We will see if this time is different.  Until then we will let the algorithm continue to guide whether we stay in the market or not.

Oil prices have gotten hammered in the last couple of months, which was to be expected given the Iran deal, economic numbers etc.  This is the one area in our ETF portfolios that has been a challenge.  We are aware of the recent swing of negative headlines and such related to oil, and certainly in the short-term we can understand why the price has gone down.  We believe in the longer-term oil is well below what it’s fair value is, and we also think that it won’t stay low like this for too long.  The economy has been grinding along, but it hasn’t stalled out.  We wouldn’t be surprised to see the numbers get a little better towards the second half of the year.  With oil prices so low right now there is no inflation to speak of, and with the weaker second quarter data, the Federal Reserve will have to think long and hard about raising interest rates.  We are thinking they may continue to hold off past September.  That should be good for stocks and oil prices.  “The Stock Trader’s Almanac” reminds us that the third year of a presidential term has historically been the best by far, so we have that going for us too.  You never know how things play out, but either way we think we are ready.

Over the last few years we have heard all kinds of silly narratives about the U.S. dollar and how it will get devalued and may lose its precious “reserve currency” status.  We’ve also heard about how gold would be the answer and on and on.  We’ve taken an excerpt from an article that we thought would be helpful and shed some light on the fallacy of all of this nonsense regarding the demise of the U.S. dollar:

Ever since Quantitative Easing began, a group of so-called Monetarist/Austrian thinkers have predicted “hyper-inflation” and the demise of the dollar as the world’s “reserve currency.”

In spite of the fact that gold has fallen and inflation remains low, scare stories about other countries dumping their Treasury securities, US interest rates skyrocketing, and a return of the trauma of 2008 proliferate. And, if that’s not enough, according to the pouting pundits of pessimism, the Federal Reserve won’t able to address the problem because long-term rates will be headed up, rather than down.

Now, these pundits have another flash point of fear because the International Monetary Fund is considering adding the Chinese currency, the yuan, to the basket of currencies it recognizes as “reserve currencies.” The yuan would bring the IMF’s list of key currencies to five, along with the dollar, yen, euro, and British pound. (Notice how no one is worried that the euro, yen, and pound already have that status.)

The idea that the IMF’s decision could trigger a selloff of US dollars and Treasuries makes no sense. The IMF’s “currency,” called Special Drawing Rights (SDRs), is an accounting tool only; it’s not used as a store of value across time. By contrast, the key issues that decide whether the dollar maintains its status are the foreign appetite to own dollar-denominated securities, particularly Treasury debt, and the dollar’s share of international transactions. And in those two areas, the dollar is doing better than ever.

Back in 2005, foreign entities – foreign central banks, foreign companies, foreign individuals – were willing to own $2 trillion of US Treasury securities, equivalent to about 15% of US GDP and 4.5% of global GDP. Today, foreign entities are willing to hold about $6.2 trillion in Treasury debt, 35% of the US GDP and 7.9% of global GDP.

Even with these large holdings, there is likely more growth ahead. Imagine what’s going to happen as India’s economy continues to expand. As the Indian central bank issues more local currency, it must decide how to back it, and will likely choose dollars. Right now, India owns just $100 billion of US Treasuries, while China owns about $1.3 trillion. As India grows, demand for US Treasury securities will rise.

No one should become completely complacent. The dollar “could” eventually lose its reserve currency status. But to lose that status, another country (or region) has to issue a currency that is stronger and safer than the dollar over long periods of time. The Swiss Franc probably passes that test, but the Swiss economy is just too small relative to the world economy for it to be a key reserve currency.

The dollar’s status as the world’s key reserve currency isn’t going away, and neither are the stories about the imminent demise of that special status. 

That was written by Brian Wesbury of First Trust Portfolios.  We think it’s the best assessment of the situation we’ve read yet.  Many thanks to Brian for sharing his thoughts.

Lastly, we want to thank you for your patience through our recent broker dealer change.  We are happy to report that things couldn’t be going better with the new firm, and it just confirms that we made the right choice.  We really appreciate your continued trust and confidence and we believe we are now in the best position we’ve ever been to deliver the best experience possible for all of our clients.  The tools and resources available to us are the best we’ve had and the people we are now dealing with have been exceptional.  The transition has gone much smoother this time around and things are getting processed much faster and more efficiently.  If you’ve already returned your paperwork we thank you and are happy to report that your accounts are being handled as we speak, and may have already come across.  If you have not returned your paperwork, then please do so at your earliest convenience.  We cannot provide any service, such as processing withdrawals or other vital procedures without your completed paperwork to move your accounts across to First Allied, our new broker dealer.  Thanks again for your efforts in this area.

Best regards,
Terry Sawchuk

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