Now that it has become clear to many that the rally in equities since March may have gone too far too fast, I detect a common theme among financial journalists and pundits. Simply stated, they point out that the U.S. is running historically high fiscal deficits concurrent with the Federal Reserve printing money (creating reserves) to purchase debt and support declining asset prices (supporting the large banks). The implication? That the U.S. dollar is rapidly depreciating, and therefore any investment in the U.S. Treasuries defies common sense.
At first blush, this reasoning seems to make sense. But let's take it to the next step -- why single out the Treasuries? ANY dollar-denominated asset must be eschewed: equities, real estate... everything. Wouldn't you agree?
How many times have you heard about this Armageddon-style scenario -- that the soaring Treasury sales and the decline of the dollar will prompt foreign governments such as China and Saudi Arabia to stop investing their trade-earned dollars in U.S. securities? But here's the reality: They are not selling their depreciating dollar-denominated assets -- they are buying more. So far, foreign investors have bought 43% of the $1.41 trillion of Treasury notes and bonds issued this year -- versus 27% of the $527 billion sold in the same 2008 period.
Yes, America's fiscal problems are big, and intuition alone should tell investors to look elsewhere for security. Well, pardon my bluntness, but who said that investors -- be they governments or individual speculators -- had that much common sense?
Besides, there are no real alternatives to the dollar. We continue to use dollars to buy homes, make investments and pay debts because we believe in the “Full Faith and Credit of the United States Government." Yes, China owns trillions of dollars and is our largest creditor -- but is the yuan a real alternative to the buck? An artificially depreciated currency under the auspices of an opaque, totalitarian government? Please. And where would China’s economy be in the first place without the massive funding of America's debt? China has no choice but to reinvest its dollars in the U.S. to fund our further trade in their goods.
Well, if China is not an option -- Europe, then! The euro must be a better alternative than the dollar. Think, though: Even the combined economies of the euro zone still do not add up to that of the United States. While the economies of France and Germany are significant, they must deal with the economic vagaries of many of their struggling sister states, including Ireland and Spain. And can we really have confidence in their common defense? After all, who is the major supplier of arms to Western Europe and who is the major supporter of NATO, both financially and materially? The United States.
Perhaps a basket of currencies, then, under the administration of the World Bank or International Monetary Fund. No -- because the majority of support for these bodies again comes from the U.S.
The fact is, there are no good alternatives to the U.S. dollar. Gold? Yes, as an investment and hedge against inflation; Bob Prechter has recommended owning some gold and silver for years. But what we are dealing with is deflation. Also, gold is not legal tender for exchange of goods and services in the U.S.
That leaves us with the U.S. dollar. Despite all its weaknesses, the greenback is still the best option among bad choices. The fact that the U.S. Treasuries rally strongly in times of crisis and during deflation indicates that most people still see this fact clearly.
Bill Fox is the editor of EWI's Interest Rates Specialty Service. Bill has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional traders spread around the globe.