Continued Dollar Depreciation or Newfound Dollar Strength?

January 12, 2012

BY: Robert Hallberg, Topics: US Dollar

We have seen a long trend of dollar depreciation but the US dollar has recently been hitting a 52 week high and outperformed most other currencies. Does this mean that the financial problems in the US have been solved and a new trend towards a stronger dollar is emerging?

Hardly! With all the problems going on in the world the US dollar just look like the âleast uglyâ currency at the moment. We will see continued dollar depreciation over time, but there is no immediate risk of collapse as there may be in Europe. The chart below shows the broad dollar index which has been rallying since the middle of last year.

Trillions of dollars flows through global financial system, from one country to another and from one currency to another and the majority of this capital is controlled by large banks, funds and other institutions. The flow of funds causes currencies to fluctuate as huge amounts of money are looking for a safe home. During the end of 2010 when QE 2 was announced, large amounts of capital fled the US into the Europe, and Japan, pulling down the dollar in pushing up those currencies. Then problems in Europe surfaced and the flow of funds was reversed.

Flows of money are going into other currencies as well but the system requires very large economies to absorb these huge flows of capital. If you or I purchase a few of thousand dollars of a small currency like the Norwegian Krone nothing would happen, but if a major bank such as JP Morgan or Goldman Sacs goes out and buy billions of the Norwegian Krone the currency would spike. There simply isnât enough of that currency to absorb large flows of capital. Only a few large countries and regions are capable of absorbing any significant amounts of capital flows. They include the US, the European Union (EU), and Japan.

As all this institutional money is floating around world looking for a safe home, the US dollar has been the favorite for the past couple of months. But as soon as the world takes their eyes off the problems in Europe the US dollar will get under pressure again. The US dollar is still far below its highs in 2009 and if you measure the dollars purchasing power against other tangible goods the result is even worse.

The chart shows a long term trend of a dollar depreciation since we went off the gold standard in 1971. The root of the problem has been excessive money creation and without an anchor to gold or other tangible assets it has become too easy for central bankers and politicians to print money and give the economy a temporary boost.

Chart â Purchasing power versus money creation

The US dollar is currently worth only 18 cents of a dollar in 1971, and this trend will only increase in speed with the extraordinary amount of stimulus and money printing that started in 2008.

The dollar might be a temporary safe haven when there is turmoil around the world but it is not a long term store of value. Therefore I suggest investors allocate a good portion of their portfolio into gold and precious metals.

To learn about trends and spot the next investment opportunity read the Casey Report from Casey Research. It's a monthly investment news letter that breakdown economic trends in a way that is easy to understand. They make recommendations based on economic reality and their track record is several times better than the market or any mutual fund for that matter.