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Sunday, November 7, 2010

Public has huge faith in the US Dollar

The valuation of a currency is not as scientific as one may think. There is a mix of accounting, national economic profile, and public faith that combined creates a perceived value of a currency. As previously described in my post series What is Money?, Currencies are merely a debt note. A promise that for work done today, you can exchange the debt note to get work done in return for you in the future.

A currency that devalues in essence is the manifestation of the view that the promise for tomorrow is not looking so promising. In essence a cheap currency means, your "value" of a promise isn't as good as someone else's.

A complete currency collapse is where the faith of the currency is basically gone, and the currency enters into a valuation free fall. In a country like Zimbabwe, you must get paid daily, and spend 100% of your money the same day to get some sort of value out of the work you did.

In essence, there is no faith at all that the currency may hold value beyond a day. And even then, the prices may vary greatly during the day depending on the vendor and item to purchase.

A primary aspect on why I like natural resources is NOT because I am afraid of the US dollar going into a free fall. It is based upon as India and China citizens have more wealth, they will consume a greater portion of the world resources. That will drive resource costs up, forcing Americans and western countries to spend a larger part of their income on basics, such as food and energy.

In a different post, I'll explore my concerns over the US Dollar.

Right now, we are seeing the interest rates for US treasuries at all time lows. Frankly, there is really almost no room to go down anymore.

What does this tell me? Well, the US has been spending enormous account deficits, into the TRILLION per year. The demand for US bonds is so great, that even with huge issuance of new debt, the premium (interest rates) for US bonds is collapsing.

The message is, there is HUGE faith that the US dollar will not have a currency collapse. That is why sub 2.6% interest for a 10 year bond is acceptable. There is enormous amount of money pouring in, from everywhere, to buy 1, 5, 10, and even 30 year US Treasuries. The over 13 trillion dollars of outstanding US debt means that everyone, but everyone has enormous faith in the US dollar.

The US stock market capitalization across all stocks is about 17 trillion, the world stock market capitalization is around 50 trillion. 13 Trillion of US government bond debt is quite a striking number when compared to these others.

Below is about a 2 year graph of the US valuation, as compared to other currencies (not as compared to resources). The yellow area is where I get real concerned the US dollar is headed for a new low. If we enter the red zone, the next level is unknown.

Considering the US dollar is near a bottom in valuation, and bond purchasing is at a all time high, with all time low interest rates, this is proof positive the world has huge faith in the dollar will not devalue. So to me the argument that everyone expects the US dollar to fall is quite false. Quite possibly many financial analysts or traders think the dollar is in for trouble, but this is a very tiny amount of "consumers" of US Treasuries.

I consider what we may witness in the next 12 months is a flip, from extreme US Bond BULLISHNESS as we are seeing right now, to one of pessimism. We are displaying near zero concern for the US bond market, and the value of the US dollar it is supported by, as a place of wealth storage. We are seeing, the end of the greatest US Bond faith ever seen as 13 trillion dollars is held by investors.

For some nice Economist articles on Debt, see "The Global Debt Clock map", "Borrowing is now a problem", and "World Debt".

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