Capital Heads Home

August 31, 1998 – Something unusual happened this past Thursday and Friday that made me stand up and take notice. As the stock market was falling, the Dollar was getting trashed. The Dollar dropped against all the major currencies, and against the best ones, it fell hard. For example, in those two days the Dollar lost 4.5% against the Swiss Franc. By Friday the Dollar was even falling against the lowly Canadian and Australian Dollars, currencies that had been in a free-fall in recent months. We have not seen such severe Dollar weakness for some time. What is going on?

My conclusion is that the tide has finally turned for the Dollar. Capital is heading home, and the implications for the Dollar, the US economy and the stock market are ominous indeed.

Long-time readers of these letters know that the Dollar is in a long-term bear market. It does have bear market rallies from time to time, like the one the Dollar enjoyed over the past few years. But I have pointed out before that all the talk about “Dollar strength” was misguided. The Dollar has not made a new high against the Swiss Franc and Deutschemark since August 1997, so it would be more precise to say in recent months that we have been seeing Yen weakness, not Dollar strength.

Also, the drop in the Yen goes a long way to explaining the drop in the Canadian and Australian Dollars. Both of these countries are heavily dependent upon exports to Japan, so as the Yen fell, these two currencies fell along with it. But now the currency markets appear to have reached a turning point. The Dollar is falling against all currencies and falling fast. And it is significant the stock market is dropping at the same time.

Overseas investors are cashing in, and turning their Dollars back into their home currency. Capital is heading home, perhaps due in part to the Russian crisis. The Russian financial collapse is showing the fragility of the international monetary situation.

For example, the Russians have reminded investors it only takes some politician’s edict to close any financial market, freezing their assets perhaps forever. And we have also seen the weakness of the IMF. Their $5 billion loan was used by the Russian government not to repay debts but to defend the Rouble! That $5 billion is gone, the Rouble is gone, but the debts remain. More ominously for the Russians and other countries that may soon need some IMF largesse is the IMF’s own precarious financial position. The IMF is running out of money, a prospect that is further spooking international investors

The disarray in financial markets throughout the world is made even more stark by the absence of US Treasury Secretary Robert Rubin. Where is he? Why has he had nothing to say about the current crises?

You will recall that his strong Dollar policy, which is of course the right policy to pursue, was overruled in June by Clinton for political reasons – the Treasury at the time asked the Federal Reserve to sell Dollars and buy Yen before Clinton’s trip to China. Now the Dollar has all the earmarks of beginning to spiral out of control.

Does Mr. Rubin believe he has been undermined, perhaps neutered, because Clinton politicized the Dollar by showing he is willing to manipulate the currency for perceived short-term political gains? Or perhaps, has Mr. Rubin disappeared because he senses that the current crises are terminal, that the regime of worldwide fiat currencies in place since Nixon abandoned the Gold Standard in 1971 is about to end in tears?

What we are seeing I believe is the beginning of a flight from currencies worldwide. The bear markets in Asia have finally brought bear markets to the US and Europe. In a bear market, fear rises. This fear causes investors to seek safety, and they do this by bringing capital back to their home shores. For safety, capital is once again heading home.

Countries like Korea, Indonesia and Russia had been living on borrowed money. Unfortunately for them, they learned that borrowed money is also hot money. And which country is the biggest borrower of hot money? The United States. It is the world’s largest debtor, which has caused the global economy to be flooded with Dollars.

When the world believed in Mr. Rubin and his strong Dollar policy, the US scraped by without any adverse effects. But now the tide is turning. Mr. Rubin is nowhere to be seen, his strong Dollar policy in shambles. And so too will the Dollar soon be in shambles, even against what has been a weak Yen.

Speaking to his nation on August 26th, Japan’s Vice Minister for International Affairs Eisuke Sakakibara said: “It is important for Japanese investors to lock in profits in any foreign currency transaction.” He did not elaborate, but he didn’t need to. The message was clear.

If you were short Yen, close out your trade. If you owned foreign assets, like US stocks and T-Bonds, sell them and bring the capital back home. The Japanese government is about to take action to strengthen the Yen.

The Dollar’s rise against the Yen has ended. We can therefore conclude that the Dollar has now peaked against all the world’s currencies. So the Dollar has only one way to go from here – down.