By Kris Sayce
By Dan Denning, Editor & Publisher, Australian Wealth Gameplan
The best way to think of the Australian dollar at the moment is that it’s a transitional currency between the U.S. dollar and the Chinese Yuan. It takes one-hundred-and-five U.S. cents to buy an Australian dollar at the moment. And even though that is a post-float high for the Aussie, it keeps smashing higher through any technical resistance that gets in its path.
There are two conclusions to draw from this. The first is that the Aussie has emerged as what I’ve called a “lifeboat” asset; the kind of place you take your money when you’re getting off a sinking ship. There are other assets that qualify, though. And we should have a look at what they are.
When we do, we arrive at the second point made by a correspondent of mine in a recent email: you should add to your long-term positions on weakness, not chase prices higher. This is especially true for gold and silver.
But first, a few more words on currency developments. Pimco’s bond guru Bill Gross gave a stirring summary for why you should not buy U.S. Treasury bonds and why you should be mortally afraid for the U.S. dollar. You can read his essay here.
The U.S. dollar, as you know, is hampered by the long-term liabilities of the U.S. government (US$65 trillion and counting) and short-term deficits that don’t seem to be getting any smaller ($1.4 trillion in 2009). I don’t know many Australians lining up to buy U.S. bonds. But if you were, Gross’s article would probably change your mind.
If anything, Gross highlights one of the alternatives to the debt problem that I raised in January of this year. There are only three real ways to deal with a massive debt problem: refinance it, restructure it, or default on it.
Australia, for example, is trying to refinance wholesale bank debt (at least in part) with covered bonds. I’ve written about these in the Daily Reckoning, so I won’t elaborate here. But my point is that because there was no public debt crisis in Australia and the GFC wiped out mostly non-bank lenders or the most over-leveraged firms with the worst balance sheets, the remaining banks here can refinance debt, even if it is a bit more expensive than they’d hoped.
That is not the case in Europe. For example, Ireland said its banks would require another $34 billion in capital to shore up its four remaining banks (the other big four?).
Regulators arrived at this number after factoring in the weak Irish economy. Yields on 10-year Portuguese government bonds rose to 8.6% or 530 basis points over German Bunds of the same duration.
Europe is trying to restructure its debt. But it’s not working out very well. The European Central Bank is about the only bank in Europe willing to lend the Irish money. And the ECB does it because it has to and, after all, it’s not real money anyway. In the meantime, the Europeans are busy trying to replace the European Financial Stability Facility (EFSF) with the European Stability Mechanism (ESM).
Aside from being a shorter acronym, the ESM requires unanimous approval by Eurozone nations in order to spend bailout money. That seems like a potential obstacle to its effectiveness. There is also the matter of funding the ESM. How do bankrupt governments manage to top up a collective fund they use to bail each other out?
If enough people thought about the absurdity of the above scenario, they might realise the only way for Europe to keep bailing itself out is for the European Central Bank (ECB) to print money. But the ECB’s current president Jean-Claude Trichet doesn’t want to do that. He said inflation is “now durably above the common definition of price stability in the Euro zone.”
The simple answer to that problem, if you’re a central banker, is to change the common definition of price stability and permit more inflation. Rhetorically, it can work. Practically, people tend to notice when they’re paying higher prices for food and fuel.
This leads me to believe that in order to prevent a wider loss of confidence in the euro and the ECB, Trichet may go beyond saying hawkish things and actually raise interest rates when the ECB meets later this month. For one, the oil price needs containing. But Trichet really is the last central banker on the planet that seems to take his mandate for price stability seriously.
But when you look at Europe and America in any kind of fine grain detail, a default (or de-facto default) seems almost inevitable. The ECB can finance and refinance bailouts for a while, but to the detriment of the Euro’s credibility as a reserve currency. And in America, there is near zero political will to restructure America’s long-term obligations by eliminating entitlements.
The trouble is, for the mercantilist exporting nations of the BRIC’s world, there’s no deep, liquid currency in which you can convert your U.S. dollars into something that’s not going to lose purchasing power over the next five years. This is where the Aussie dollar comes into play.
The Aussie is a high-yielding, China-correlated currency that seems to have beaten its reputation (for now) of being a “risk on” currency play. Of course, maybe this is just the kind of thing people say at the top to justify an over-valued currency. But as a commodity currency of a country with a low public-debt-to-GDP ratio, you can see why the Aussie would be a lot more attractive than a lot of paper money alternatives.
One of the big reasons it remains attractive is that the world’s investors can’t invest in the Chinese Yuan as a reserve currency, at least not yet. In the October issue of Australian Wealth Gameplan I wrote about how China’s central planners have 2015 circled on their calendar. That’s when they need to have ticked all the boxes that make the Yuan usable as a global reserve currency, fit for inclusion in the basket of currencies that make up the Special Drawing Rights (SDRs) issued by the International Monetary Fund.
Jim O’Neill from Goldman Sachs, who’s in Nanjing coincidentally for the meeting of G-20 finance ministers, says that 2015 is too far away and that China’s currency needs to be included in the SDR basket sooner. China’s currency is not fully convertible yet, but O’Neill says that’s not a problem. He says, “By 2015 China will be so big in the world, it will be embarrassing for the international monetary system if it’s not in it.”
This leads me to believe that Goldman is somehow massively long the Yuan and hoping to make a lot of money very quickly by expediting its inclusion into the SDR basket. It also highlights a problem. A problem for which there doesn’t seem to be a solution right now. And a problem that benefits the Aussie dollar (and gives you more time to build your position in gold at lower prices).
The problem is that the Chinese don’t want the Yuan to be convertible because they don’t want it to be stronger. A fully convertible currency is one that international speculators can buy and sell in a deep and liquid market. Right now, a lot of speculative money would flow into Chinese Yuan if it could; creating even more loanable funds in China’s banking system.
Inflation is already bad enough in China. The last thing the regulators and central planners want is a tidal wave of money moving out of U.S. dollars and into the Yuan. So China resists the revaluation of its currency and the full convertibility that would be required for the Yuan to become the next global reserve currency.
Everyone seems to think it’s a dead set certainty that the Yuan WILL become the next global reserve currency. After all, China has the world’s second largest economy. At its current pace of growth, it’s only a matter of time before it overtakes the U.S. This is what all the speculators would like to bet on now.
But they can’t.
So we’re back to square one. If you can’t bet on China’s currency and you don’t want to bet on the dollar and you can’t bear to bet on the euro and you sure as shooting don’t want to bet on the Japanese yen, then you are left with the next tier of less-liquid but higher-yielding currencies.
One of which is Australia’s own fighting kangaroo, the dollar.
[Ed note: If you’d more advice about how to protect your wealth, you can sign up for a 30-day no-obligation free trial of Australian Wealth Gameplan by clicking here…]
Happy Easter.
Cheers,
Kris Sayce
Money Morning Australia
