Altered State of the Union

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This year, you can hardly throw a stone in any direction without hitting an economist who tells you why the dollar will continue to be strong. Our advice: throw it good and hard.

We recall more than a year ago or so, we thought the dollar should go down. What bothered us was that so many other people thought so too.

We have never seen a line of people we wanted to join. In the investment world, crowds cause you to lose your money. In the rest of the world, they cause you to lose your dignity, and occasionally, as illustrated by the recent news from Mecca, your life.

The “crowded trade” is one you want to avoid, because if it is too popular, the profit has already been taken out by the people who go there before you. They’ve bid up the price so you’re no longer getting a bargain. And if your side of the trade is crowded, who is left to take the other side? If there are no fools ready to buy what you are selling, or sell what you are buying, then you are the fool.

We remember being bothered by the fact that too many people thought the dollar would go down. Markets do not usually reward the crowd; they punish it. But how could the crowd of people who thought the dollar would go down be punished? The dollar was almost certain to go down, we figured. Where was the surprise? What would happen that investors did not expect, which caught most of them off guard?

Either the dollar would not go down, we figured, or it would go down a lot further and a lot faster than expected. In the first scenario, almost everyone would be surprised — including Warren Buffett, who was short. In the second, those who expected a graceful decline in the greenback would have been delighted and satisfied with a 10% drop. They would have congratulated themselves and taken their profits; then, the dollar might have slipped 10% more. One way or another, there had to be a surprise coming.

There was. And it surprised us. The dollar rallied. From under 130 to the euro, the buck rose to over 120. (That is, you got fewer dollars per euro.) It happened because the Fed was raising rates, and because the news from Europe was discouraging; the euro bottomed out after the French failed to ratify the new European constitution.

Now, the rate increases are just about over (only another 25 basis points are expected). The cars have stopped burning in France. The Germans have a new person at the head of government. Europe has a positive trade balance, and it isn’t spending a trillion dollars trying to bring the desert tribes under control.

And so, the euro gains.

Meanwhile, Japan finally seems on the mend after 15 years of collapsing asset prices and consumer price deflation. Foreign investors are going back into the Japanese market and pushing on the yen.

And, from America, the news is worse than ever. The United States has the biggest trade deficits ever, with a $1 trillion federal deficit projected, and a soaring money supply. The world has never seen so much wonderful money sloshing around, nor so many claims against it.

Once again, the dollar seems sure to go down. But now, investors seem not to notice. “Buffett was wrong,” they say to one another. See, the big dope isn’t so smart after all. Buffett has always said, “You can never make money betting against America.”

The world is full of surprises. In the financial world, there are so many of them that we are surprised when we are not surprised. Last year, investors were surprised when the dollar didn’t fall. This year, we may be surprised by how much it does.

• While the dollar rose against foreign currencies last year, it fell sharply versus the “real money” against which all currencies are ultimately measured: gold. Financial risks are inversely correlated to the perception of them. When people see no clouds on the horizon, watch out. It is sure to rain.

The average investor’s appreciation for risk seems to be at an epochal low. He looks right. He looks left. Nowhere does he see anything to worry about.

He must have his eyes closed. For on both sides, as well as in front and behind, are the biggest financial risks in history — never has so much money and credit gushed into the world financial system…including an estimated $200 trillion in derivative contracts.

So far, only gold seems to see the risks. The price has doubled since George W. Bush became president. Our guess is that it will double again before he leaves office.

Again, there are always surprises. No one knows what gold will do, but all know what it will not do. It will not disappear as a store of value.

• We took the train down from Paris last night. Then, we drove to the airport in Limoges to pick up Maria and her friends. This weekend is Maria’s 20th birthday. She wanted to come to the country in France to celebrate.

Driving down to Limoges, the fog was so thick we could barely make out the car in front of us. We were sure were wasting our time; the airport would be closed. No pilot would land in this fog, we thought. Then, when we arrived at the airport, gauzed as it was in dense fog, there was barely a sign of life. It looked as though the whole place had closed up and everyone had gone home.

The airport is very small and very relaxed. There are no security announcements…and no police patrolling with automatic weapons. There is not even a parking guard. We pulled up in front of the terminal, turned off the engine and walked inside. Almost everything was closed, but there at the bar, we saw Maria’s smiling face.

“How did the plane land in all this fog?” we wanted to know.

“I don’t know, Daddy. I looked out the window and I thought we were still up in the clouds. And then it banged down on the runway. We couldn’t even see the runway lights.”

Ryanair. One of Europe’s upstart discount airlines: London to Limoges, roundtrip for less than 40 pounds. Pray for them.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.

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