Footprints of Diversification from Dollar

August 25, 2011

From its highs in 2010 to its lows this year, the U.S. dollar fell over 10% against assorted other widely traded currencies, and it is quoted presently much nearer to the 2011 lows than the 2010 highs.

Dollar vs 2010 High 2011 Low % Change 08/25/11
Euro 1.1875 1.4939 -20.5% 1.4408
Yen 94.98 75.93 -20.1% 77.14
Swissie 1.1730 0.7066 -39.8% 0.7969
Pound 1.4232 1.6745 -15.0% 1.6334
C-dollar 1.0851 0.9403 -13.3% 0.9830
A-dollar 0.8068 1.1080 -27.2% 1.0477
Kiwi 0.5563 0.8840 -37.1% 0.8304

Many factors suggest that the dollar ought to have trended higher instead.

First, the past 12-18 months have been a period of ultra-high uncertainty and general risk aversion.

Two, the euro area’s debt woes have developed as badly as one could possibly have imagined.  A widening of the Greek-to-German yield premium to 1,565 basis points on July 18 provoked a second, larger bailout plan for Greece.  After narrowing to 1,191 bps on July 22, it has grown past the old maximum to 1,609 bps as of yesterday.  Investors worry that European leaders lack the will and means to restore confidence in the viability of economic and monetary union.

Three, Japan suffered the mother of all natural disasters in March.  As a percent of GDP, Japan’s debt exceeded U.S. and European levels by a substantial margin even before the earthquake, tsunami, and ensuing nuclear accident.

Four, the United States has better demographic properties for coping with the challenging problems of coming decades.

Five, the political infrastructure is performing poorly everywhere.  No currency ought to be disadvantaged because this is a widely shared negative factor.

And six, in comparisons of economic growth, the United States has been the one-eyed man in the land of the blind.  The table below shows the growth of real GDP from a year earlier.

GDP 2008 2009 2010 2Q11
U.S.A. -0.3% -3.5% 3.0% 1.6%
Euroland 0.4% -4.2% 1.8% 1.7%
Japan -1.2% -6.3% 4.0% -1.0%

The paradox of dollar depreciation in the face of the above supports is best explained by a constant din of currency diversification transpiring in the backgrond.  Countries like China and Japan have way more dollar reserves than they need.  The best chance that individual investors have for preserving capital in uncertain and fragile times like the present lies in diversification, and the same remedy applies to sovereign currency portfolios.  Not that further impetus to diversify is required beyond this truth, but big dollar holders probably worry about the dollar’s long-term track record as a store of value.  The greenback has lost net ground on every presidential watch since Nixon except Clinton’s.  Over the last half century, the dollar has lost 78.6% against the yen, 81.8% against the Swiss franc, 66.2% against the synthetic mark, and 98% against gold.  Enough said.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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