Thursday, November 11, 2010

Trouble ahead for the greenback

Imagine buying a commemorative plaque that included a certificate of authenticity and had been issued in a limited quantity to uphold its future market value.  However, what if the plaque manufacturer then started freely distributing without limit, and possibly even giving the plaques away after you've been one of the earlier purchasers of the special commemorative piece - what do you think might happen to that value for the one you're holding?  If you said it would drop in value, then you are correct!  It wouldn't take long for those holding such plaques to realize they've become practically worthless or at least certainly diluted in value to the point of being much less than the price originally paid to acquire it.

Well, that is what is happening with our once mighty greenback.  Yes, the US dollar, being the reserve currency of the world, and no longer backed by huge quantities of gold but the good faith and trust of the US government and its people.  Yet, once again, we are squandering that trust with our monetary policy to print dollars to buy US Treasury bills and bonds on the open market. Our policy makers are of the belief that diluting the value now to stimulate the economy will provide greater rewards for dollar holders in the future by way of increased economic activity, a more economically stable America and therefore a stronger greenback.  Unfortunately, we all know better than to trust such large scale trickory and in particular its attempt to manipulate human behavior without much of any substance behind it.  Just because the government wants everyone to feel good and start buying/hiring, etc. doesn't mean we're going too!

The US continues to act as poor stewards of the world's reserve currency and I believe we will pay the price for it.  Not only will QE2 not work with stimulating the demand of the American economy but it will further depress the value of the dollar in the not too distant future.  Basically, the US dollar is being secured by IOU's of the US which is like being insolvent and acting as the guarantor of your own debt as security for others.  For now, it's not likely to have much more impact of depressing the dollar after its widely anticipated $600 billion purchase announcement unless the Fed decides to do more than that.  But, in subsequent years, when the true ramifications of the measures come into play, it will wreak havoc on the currency. 

For now, there is much hope that it will stimulate demand in America but likely there will be soverign debt issues of other countries in Asia and Europe that will provide support for the US dollar before such debt troubles spread to the US and cause the selling of US dollar like there is no tomorrow.  Just be prepared to diversify when the dollar gets much of its strength back momentarily.