With the world focused on the European banking crisis, the other side of the Atlantic isn’t looking much better.
Like every country in the world, the United States is bankrupt. Yet it should be the last domino to fall. Being the heaviest domino, the US — the world’s largest economy — needs the weight of the other dominoes to crash and bring it down. That will happen when the sovereign debt crisis turns global.
When the global debt crisis heats up in the months ahead, capital will flock into the US dollar — the world’s reserve currency. Legendary commodities investor Jim Rogers toldThe Economic Times,
‘I own the US dollar. It is my largest single currency. I do not have any confidence in the US dollar as a sound currency. It is one of the most flawed currencies in the world. The US is the largest debtor nation in world history and it is getting even worse. I own it because there is more turmoil coming in the world and in such times, people seek a safe haven.’
The king of commodities is spon on. The US dollar is about to enter a prolific bull market. There’s reallynowhere else for institutions to put their money. When this happens, the world economy will crash. Of course, there’s always a way to survive and prosper.
To start, let’s review the US dollar index — a basket of currencies weighted against the US dollar. Here’s a look at the current configuration:
Source: Source: Outstanding Investments
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The breakdown shows the euro makes up 57.6% of the US dollar index.
The Eurozone — where the euro is used — is an absolute disaster. Greece’s economy still hasn’t recovered from its bailout — and it will probably leave the Eurozone this year. Spain still can’t form a government. The Italian banks are riddled with 360 billion euros of bad debts. And Deutsche Bank — Germany’s biggest lender — has shown signs of going under.
The other major currencies in the index — the British pound and Japanese yen — aren’t much better.
Following the Brexit vote, the pound is trading at 31-year lows. If it doesn’t leave the European Union (EU) before it crashes and burns, the currency will go down the drain in the years ahead.
The Japanese yen is still a basket case. Abenomics, the policy package created by Japanese Prime Minister Shinzō Abe, is a total failure. It hasn’t stimulated the economy. The Bank of Japan is moving towards deeper negative rates. Making matters worse, it hinted at passing these costs on to deposit holders this year.
Where do you think capital will flow during times of chaos?
You got it.
Smart punters will move their money into the US — one of the only places in the world with positive interest rates. Of course, it’s not that simple. The US has the most advanced financial system in the world and, the majority of people ‘trust’ the dollar.
With a catastrophic financial meltdown looming — possibly the greatest of all time —the US dollar is going much higher.
In my view, that’s great news for US treasuries (short term debt) in the near term, but not so good for US denominated assets and bonds (long term debt). For example, the US dollar has historically had a negative correlation with gold. You can see this on the chart below:
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The chart above compares the gold price with the broad trade-weighted US dollar index over the last 10 years. The trade-weighted US dollar index, also known as the broad index, is a measure of the value of the US dollar relative to other world currencies. The US Federal Reserve tracks the trade-weighted US dollar index closely.
The broad index measures the greenback against the currencies of 26 economies according to the size of bilateral trade. China, Mexico and Canada make up 46% of the gauge. If you read the mainstream media reports, those economies aren’t in great health. As such, I expect this dollar index to skyrocket in the years ahead.
Focusing on the chart above, the gold price (shown in blue) and the US dollar index (shown in orange) have had a strong negative correlation over the past 10 years. Although this relationship has altered a bit, the correlation has mostly continued over the past couple of months. You can see this on the chart below.
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The chart shows the US dollar (orange line) crashed when gold (blue line) surged higher into May. As you can see, when the US dollar rose sharply, gold pulled back by around $100 per ounce during May. The past two months have been a bit different. The US dollar has mostly rallied with gold.
The question is: will the new relationship continue going forward?
Based on history, and with gold trading around major resistance of US$1,360 per ounce, which I discussed on Friday in Money Morning, I have my concerns. While the positive relationship may become the ‘new normal’ in the years ahead, I expect the old relationship to return first.
It’s simple to understand why…