April 8, 2011

 There is a reason export surpluses have been so vigorously sought after by nations for centuries. Exports cause a temporary boom.  As exports increase, money comes into a nation and into the coffers of the businesses and industries that do the exporting.  This leads to increased profits in all businesses connected to the export industry and spreads throughout the economy creating a temporary burst of economic activity as business profits spill over to increase employment, raise stock prices, and the benefits spread throughout the general population. 

But this also induces inflation which eventually cuts off purchases as higher prices dissuade consumers from buying.  The result is a mild reduction of economic growth--unless--the exporting nation depreciates its currency further, making its exports attractive again.  This was the standard operating procedure of most nations who pursued export surpluses for the last 60 years.

The recent fall in the dollar, which was somewhat predictable--and necessary--is for the first time not being met with other nations devaluing their currencies against the dollar.  Competitive devaluations typical of years past have become more difficult as interest rates in competitor's countries have increased and as US rates remain low and unchanged.  Our competitors have little choice but to raise interest rates and fight inflation. And where that choice has not been made by governments, the market has made it for them.  That choice has not yet been thrust on the United States.


For the first time in a very long time other currencies around the world have been going up while the dollar falls to historic lows against them.  The dollar is in the position of encouraging exports and discouraging imports, while other nations are forced to tolerate a rise in their currencies.  This has turned the international trading system on its head.


However, currency depreciation only yields temporary gains.  No one has ever devalued their way into permanent prosperity.  Our export boom might last for a while longer, but in the end it will be trumped by debt reduction and austerity measures, higher inflation rates, and higher interest rates. Eventually we can potentially find ourselves in a situation similar to Europe.


There are a lot of accusations that the Fed is intentionally depreciating the dollar to stimulate growth, and that this is somehow their “grand plan.” I disagree. The Fed's province is not the value of the dollar, internationally.  The Fed is charged with providing stability of prices domestically, back-stopping the financial system, and applying monetary policies that further non-inflationary growth. It is the Treasury that is in charge of the dollar internationally. The Fed can influence the dollar's value on international markets through its monetary and interest rate policy, but the Treasury can sterilize the effects if it chooses to through buying dollars or buying and selling other currencies to offset Fed policy.


While the Fed is responsible for the domestic price index, it is the Treasury that is responsible for the international value of the dollar. To this end the Treasury is supposed to work closely with the Fed to coordinate policy.  Both Greenspan and Bernanke have unfairly been accused of pursuing a cheap dollar policy that caused the dollar to fall.  But the rate of inflation has fallen over the years to one of the lowest rates in history under both Fed regimes. It has fallen from almost 14% in the early eighties, to .08% last year. It is the value of the dollar vis-à-vis other currencies that has fallen in recent years. This is a matter for the Treasury—not the Fed.


We hear little about the Treasury and Tim Geitner, but a lot about Bernanke and the Fed. Yet Geitner and the Treasury are responsible for the value of the dollar on international markets. What has their dollar policy been?  It has been to convince China to allow its currency to increase in value. That is about all we hear from the Treasury as far as policy is concerned. While I agree that a market determined Yaun would be a good thing for all concerned, I would save my breath. China will do what China wants to do. The Treasury needs to concentrate on what is in its power to influence rather than on areas it has little to no influence over. What Geitner can do, is at least attempt to stabilize the dollar relative to its other trading partners.


What level the dollar is at is relatively unimportant.  What is important is that it stays reasonably stable over time.  Robert Mundell, Nobel Prize Winner, architect of the Euro, advisor to China, and advocate of a return to a dollar linked to gold, argues that the Treasury should embark on a new policy to this end.  It needs to buy the Euro when it sinks and sell it when it rises.  It needs to sell the Yen when it gets to extremely overvalued levels and buy it when it sinks.  If the treasury did this, they would effectively stabilize the dollar against international currencies. Check out the following chart.




Mundell is not suggesting that we return to a fixed exchange rate system at this time.  We all know that intervention does not work to prevent markets from going where they wish.  But a more activist Treasury in the name of stability is due.  Mundell believes we can smooth out the large swings, evidenced by the chart of the dollar index, and create greater stability in the economies of the world.


Instability in foreign exchange rates that lead to wide and violent swings are disruptive and avoidable.  We have just benefited from a sharp fall in the dollar and we have seen exports increase and our manufacturing base increase the most we have seen in about a decade. This was a long needed adjustment and would have come under almost any monetary regime due to our huge trade deficit. It should be a one-time occurrence, but the temptation will be to take the easy way out and continue to allow the dollar to fall.


At the end of that road is what Europe experienced in the last couple of decades. Europe continued to depreciate its currency and saw its unemployment rate stay at near 10% rates and growth stagnate, while during the same period here in the US we had a strong and stable dollar, a 25 year boom, and the lowest unemployment rate in modern times.


Unfortunately the Obama Treasury has given no indication of wanting a stable dollar. In fact it has made exports its prime focus which benefits from the falling dollar. Like in so many other matters, this administration thinks in European terms rather than American terms, and tends towards mercantilist protectionist policies. It’s time to press the Treasury Secretary to establish a dollar policy similar to those of the Reagan/Clinton Administrations.


A strong and stable dollar was one of the pillars of Reaganomics, and it is part of the economic foundation we should now begin to rebuild.  It is still too early to expect the government to return to the discipline of the gold standard, but the time is ripe for an activist Treasury that leans towards dollar stability.  The dollar index chart illustrates the extreme movements the dollar has made over the last few years. A simple leveling out of that erratic range close to its medium level of 80 would be a sound objective. The Treasury needn't spend a lot of money to this end, it need only buy a little at the bottom of the range and sell a little at the top. Other nations may find it in their interest to do the same.  


A Treasury focused on stabilizing the dollar, coupled with 3-5% Fed increases in the money supply beginning in June when QE2 ends, and the newfound fiscal discipline we are just beginning to see in the Federal government, could go a long way in healing this nation and setting us on the path to stability and prosperity. 


We are still a few years away from restoring the building blocks of real growth in this country, but the re-establishment of a nation moving toward a balanced budget, and stable money both domestically and internationally poses an interesting question for investors: What would the investment strategy be in such a world? It is not too soon to start contemplating such a dramatic change.


Much time has been spent on thinking about how to make money in an era of increasing budget deficits and a falling dollar. No time has been spent on contemplating the profit opportunities if there were a reversal of that trend. We cannot ignore the philosophic movement occurring today. From such people as Paul Ryan, who is proposing moving toward a budget surplus; or Ron Paul, who is advocating a return to hard money; or those that are fighting the new healthcare and regulatory bills to replace them with real reform; or those working toward re-writing our tax code to make it simpler and fairer—there is an extremely powerful trend developing and its ideas are beginning to dominate the political scene.


It is time for a change in monetary policy, away from dollar neglect towards a policy of dollar stability. Such a change, if it comes, will have a profound affect on the investment landscape we have grown accustomed to.



Market Update:

What can you say about this week’s action? They say that the third leg of a bull market is the strongest and this one has not disappointed. It has been stellar. So, let's talk speculation.  A lot of the stocks I hold are exploration stocks.  These are "specs', many of which don't even trade on major exchanges yet.  If you own any stocks like these, you need to keep in mind the downside risks.  If Enron, one of the biggest, bluest, and most transparent of stocks can go bust in a week, certainly an exploration stock in the middle of nowhere can.


If you want to know what keeps me up at night, it is the age old definition of a gold mine, which is a large whole in the ground with six liars standing at the top of it.  It is for that reason that I often trim back my profits on the rise.  I will never make the max, but it amounts to prudent speculation and allows me a sound night’s sleep.


So, I'm inclined to look for further opportunities to take profits on this rise soon.  Consider it “spring cleaning”. Run's like we are seeing now in the metals are rare occurrences, and should be taken advantage of.  Copper Fox rose substantially this week as a Chinese company took over a small copper company.  This sparked further speculation that Copper Fox could be bought out.  At one time on Thursday CPF was up over 21%!


RBY continues to regain lost ground as its credibility as a possible world class gold mine has been enhanced.  Amazon Mining spiked up on the news the state was going to, in effect subsidize it by insuring it would get the financing necessary to go into production.  This insures that the company will be around for a while and reduces its speculative nature.  I added one third more to my position. It is up substantially on the news. And US Silver broke to new highs, and went up over 11% by the close on Friday.


 I mentioned last week that I intended to buy silver and that I did, picking up SLV, thereby continuing to move toward a division in my cash position between gold, silver, and dollars.  As a result my portfolio has shifted somewhat, but this week has been one of the most profitable weeks in a long time.


My portfolio by weight is as follows, and I was asked this week to give readers a sense of the percentages of the stocks I hold.  Copper fox is about 25% of the portfolio. Cash, as defined as gold, silver and dollars represents about 20%. RBY and Amazon represent about 10% each, and US Silver, and CDE represents about 8% per position.  The rest descend from 7% down to 3% at the bottom.


Portfolio by Weight:

Copper Fox Metals


Rubicon Minerals 

Amazon Mining

US Silver Corp


Lexam Gold

Denison Mines


Rochester Resources LTD