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Tightening of world liquidity good for the dollar and US markets?

August 31st, 2008 · No Comments

US turning the corner? We reported how Jim Cramer called a bottom for the US market, now there is the famous writer of the Gloom, Boom & Doom report Marc Faber arguing the dollar has bottomed. We’re not entirely sure about his argument though.

From MoneyNews:

  • Acknowledging that many investors see weaker oil prices as bullish, Marc Faber says lower oil prices actually signal that the global economy has entered recession.
  • “I think that what has happened is that starting in the fall of last year, the U.S. trade and current accounts were diminishing rapidly. It led to a tightening of global liquidity, (and) foreign official dollar reserves were not growing at the same pace as before,” the managing director of Marc Faber Ltd. and publisher of the Gloom, Boom & Doom Report told Bloomberg.
  • Whenever liquidity tightens, it leads to poor markets but is very dollar-supportive. Weak demand in the U.S., lower imports, and the demand for oil also declining led to a tightening of global liquidity,” Faber explains.
  • That’s why Faber isn’t buying stocks now, he’s buying dollars.
  • However, if he was buying stocks, Faber says he’d buy into the U.S. market because the U.S. economy is in relatively better shape than Europe’s.
  • The weaker dollar makes it easier for U.S. companies to sell overseas, and the stronger euro makes it more difficult for Europe to sell goods to the U.S., he says.
  • Faber believes the dollar will continue to rally against the euro. “My view is that after four years of under-performance, the U.S. dollar would now outperform for three to six months. I still maintain that,” Faber says.
  • “I think the dollar can continue to rally somewhat to $1.47 against the euro,” Faber observes.
  • The euro recently fell the most in almost eight years against the dollar as traders scaled back their bets that the European Central Bank will raise interest rates. Faber thinks the dollar can continue to rally somewhat to $1.47 against the euro.
  • Faber also suggests unloading commodities now. Last October, he forecast a drop in commodity prices in the second half of 2008 due to a tightening of global liquidity.
  • Faber now foresees individual commodities dropping as much as 50 percent, which some have already done, but he believes the bull market in commodities will then reassert itself.
  • “In nominal terms, we had a bear market in commodities from1980 until 1999 or 2001. “Depending on the commodity we are seven years into a bull market for commodities.”
  • Faber is also very optimistic about Japan’s economy, but very wary of long bets on steel stocks and iron companies. “That kind of thing I would avoid,” he says.

We’re not entirely sure. Global dollar supply reduces when the US balance of payments improves. A US balance of payments deficit basically means that the US buys more goods, services and assets abroad than other countries buy in the US.

The mirror image of that is that there is an excess supply of US dollars, which:

  • either leads to a dollar fall against other currencies
  • or central banks buy these ‘excess’ dollars, but they boost their own liquidity as more of these other currencies (yen, yuan, euros etc.) come into circulation.

Now, if the US balance of payment improves, less of this happens, which indeed lead to a tightening of liquidity.

However, central banks (most definitely including the FED) have pumped large amounts of liquidity in the markets as a reaction to the credit crisis, so we’re not entirely persuaded by Marc’s argument here.

In the meantime, criminals are dumping the dollar:

  • The weakened US dollar has fallen out of favor with organized crime groups to pay for drug shipments or to settle scores, a Canadian government report said Friday.

Tags: The Markets