I believe the next market we’ll see a remarkable drop in is going to be U.S. Treasuries — which, of course, is what most people would think of as “the U.S. dollar“. Treasuries are simply the bonds that the U.S. government issues in order to raise capital (in other words, an “I.O.U.”). In turn, investors are provided a return on the money they loan to the U.S. government, and this return is referred to as the “yield”. You buy treasuries in pursuit of security and safety, because you’re essentially buying promises to pay you back — promises that are backed by the U.S. government. Government Treasuries have long been considered about as safe as you can get. To put it simply, investors this week bought massive amounts of U.S. Treasuries that provide a NEGATIVE yield. Put another way, investors are buying Treasuries knowing only ONE thing — that they will NOT generate any return doing so, and will actually lose a small amount of their money. Why on EARTH would investors do this? It’s because there is so much fear in the marketplace right now, investors just don’t know anything better to do. Some investors are anticipating that the U.S. is going to see deflation, in which case the Treasuries will act as a hedge – because in times of deflation, cash (and its equivalents) gain more purchasing power. It’s also a way to try and avoid credit risk in this world of volatility and so many unknowns coming out of the wood work. Perhaps even more dramatic, for every Treasury sold, there were 3 orders that went unfilled — in other words, there were 4 times the number of investors as there were Treasuries available to buy. To me, this conjures up visions of Tom Sawyer convincing his friends to white wash the fence for him. Investors are doing things that they think make sense .. when in fact it’s serving the needs and benefit of the one behind the plan! When the money starts moving out of Treasuries, the speed and volume will be absolutely breathtaking. I believe this is just another one of the disconnected fundamentals in the market today, caused by a series of one-time, unusual, and anomalous events that make it almost impossible to have any visibility going forward. However, just like my expectation that oil will snap back (and in a violent way), all the money in Treasuries will be taken back by its owners, and it won’t be pretty when it happens. What Will Cause This “Bubble” To Pop? First, if you look at the incredible debt that the U.S. is taking on through all of the bailouts and the coming spending programs, over $8.5 Trillion of debt has been created in the last year, more than half of the entire U.S. GDP output. On a very simple level, it could only make sense to get a zero (or negative) yield on Treasuries if you felt there was virtually no risk. Yet, when you consider the massive deficit, trade imbalances and ever-rising debt being slapped on the U.S. balance sheet, does it make ANY sense to think the risk of owning Treasuries is going UP .. and not DOWN? Second, deflation is going to be a very short-term and temporary phenomenon, if in fact it occurs in the U.S. at all next year. While the government is now raising alarms about deflation, the reality is that inflation is the great risk today. With the amount of debt the U.S. government is creating (and simply running the printing presses overtime to ‘create’ it), we’re going to see a tremendous rise in the already-high inflation rate in the U.S. While I think Barack Obama is going to make a strong leader, there’s nothing he can do to stop this train from wrecking. The U.S. has such horrendous debt loads, continues to run deficits (which will only rise), and not to mention the unfunded liabilities of some $40 Trillion dollars for Medicare, Medicaid, Social Security .. it goes on and on. And where it is ends is with MASSIVE inflation. And once it becomes clear that inflation is the risk, not deflation, Treasuries will deflate very quickly, as money moves into more appropriate investments for inflationary environments (such as precious metals, etc). I beliieve you’ll see the currencies of those countries that are rich with “real” assets (such as natural resources) soar against the U.S. dollar, as global money looks for a haven from the ravages of inflation. What Does This Mean To You? Ultimately, what it means is that U.S. dollars will become less valuable, meaning that if you hold assets in U.S. currency, you’d be best to seek alternatives to doing so. While I think it can make sense to make money in the U.S. (such as taking advantage of opportunities in the real estate market in the U.S. right now), I don’t think it makes sense to hold it all in U.S. dollars. A suggestion I made to one of my clients is that they look to move some U.S. money into Canada, and then hold a mortgage against a very well selected piece of real estate. In doing so, they could move their money into a currency that is backed by an economy based on commodities (which Canada is), and also benefit from an income stream on those dollars. For example, if you take US$80,000 and convert to Canadian dollars right now, you’ll end up with about CDN$100,000. You invest that CDN$100,000 into a mortage, paying 10% interest. The payments are made back in Canadian dollars (which you leave in Canada). Let’s assume you do this for 2 years, during which time, the US$ corrects and becomes equal to the CDN$ (as it was earlier this year). You’ve made 10% on your money each year, based on Canadian dollars. That means you have your original $100,000, plus $10,000 you’ve each in each of the 2 years for a total of $20,000 interest. So after 2 years, your total account balance is $120,000 ($100,000 + $10,000 + $10,000). However, watch the impact of the currency now. You then convert your Canadian dollars back into US. Since the CDN$ = US$ now, you end up getting back $120,000 US dollars.. even though you started with only $80,000. You’ve essentially made a 50% return on your money by adding the currency hedge into the mix. Don’t like investing in mortgages? No problem. Look at some of the Canadian energy companies, which are paying attractive dividends right now, and the prices have been killed because of the market downturns. My point in all of this is that you MUST consider what fluctuations in currency are going to do to your wealth. You can’t just think of your wealth in your local currency – you need to think about it in the global context. And if I’m right, we’re about to witness a truly amazing decline of the U.S. dollar, so you’d be best to position yourself not JUST to avoid getting killed .. but to actually MAKE a killing from it. So what’s the problem? That’s easy. No one can predict WHEN this is going to happen. It could be a few days. A few weeks, or a few months. Possibly even a year, maybe two (thought I doubt it will take that long). You could place your positions and wait some time before the mechanics start to take effect. But I do believe we’ll see this shift occur sooner than later, sometime in the year 2009. In fact, in the past couple of days, we’ve already seen some indicators that the dollar’s strength is wavering. Oil shot up over $4 today, gold is up almost $100 in the last few days of trading, and the Canadian dollar was up almost 2 cents today alone. Is this just a temporary effect? Time will tell. But I believe this isn’t just a theory or possibliity, but a matter of time. And remember, if the US dollar declines, anything priced in U.S. dollars will go UP. That means oil, gold, and most other globally traded commodities and assets. So, don’t say I didn’t warn you. The bubble’s about to pop .. and Ben Bernanke and Hank Paulson have very large pins that they’re moving closer and closer to the bubble. Be ready to hold your hands over your ears, because when this one pops, it’s going to be heard around the world!]]>
10 Responses
Great post Greg. After reading an insightful post like this one, I always ask myself the questions “How does this effect me and what do I need to do to prepare myself?”
Being in Ontario, we’re very sensitive to any CDN dollar rise due to the fact that the US is our biggest trading partner since we’re automotive and manufacturing based.
With the automotive mess and if our dollar does rise, my feeling is that Ontario could be in for hard ride. But then again we also have a good amount of mining in precious metals, high tech development and aerospace manufacturing that is should offset the negative automotive impact. Very interesting times we are living in!
In your opinion, how will a drop in the US dollar effect Ontario?
I would say you’re right – Ontario is going to have a tougher ride than the western provinces, simply because it is a manufacturing province, not a resource province. The auto industry downturn is a major challenge, on top of which the US dollar declining means Canadian products cost more to most of the world.
So if the US $ does decline as I anticipate, that will put pressure on the exporting and manufacturing sectors, which are heavily distributed in Ontario and Quebec.
Does it mean total destruction of the economy? No, but if you’re asking relatively speaking, Ontario will do worse, the west will do better. In other words, we’ll continue to a similar game play out as we have over the past few years in Canada. Resource-rich provinces will prosper, and manufacturing-heavy provinces will be more challenged.
To support your argument, I listened to a very interesting presentation by Paul Van Eden in which he clarified monetary definitions; inflation is an increase in the money supply, not a measure of the increase in the price of goods (which can be a symptom of an inflated money supply). Thus deflation is a decrease in the money supply. The great depression in 1930s was a deflationary depression where the current economic ill is and will be a inflationary depression. Apparently today’s inflation rate (increase in the money supply) in the US is approx 8% which is of historic highs. Thanks for your great blog and have a great first Christmas as new parents!!
I am concern about the exchange rate factor as I am buying gold in Ringgit but the price is a conversion from USD. Since commodities such as gold are traded in US dollar, would a US inflation caused the gold price to drop or increase i.e. would the gold price increase be offset by the decrease in the exchange rate? I am seeing the spot price for gold increase in USD but dropping in Euro.
When you see the gold spot price increase in US dollars but decrease in Euros, that is because the differential between US$ and Euros is going toward the Euro.
Put another way, inflation in the US will cause the US$ to weaken. That means it will take more US dollars to buy an ounce of gold. That’s why gold prices go up if the US$ declines. It’s NOT because gold itsef is going up in value, it’s only going up MEASURED IN US $.
So, if you buy gold and the US$ declines, then because it is universally measured in US$, the price will go UP. Meaning, you can sell your gold for more US$ than what you bought it for.
The other issue here is that gold has an intrinsic value unrelated to the US dollar. So if the demand for gold goes through the roof, it will go up in ALL currencies because of the supply/demand. The currency issue is another, but separate, consideration as to what will happen with the price.
In other words, I think gold is going to head higher not only because the US $ will decline, but ALSO because raw demand for gold will outstrip supply even more than it already has.
The US dollar is certainly a cause for concern, especially when you consider hyperinflation. I still hear people say “in times of recession, cash is king”. Although this is true in a lot of cases, it’s dangerously wrong in an inflationary recession/depression. Cash becomes trash.
Anyway, I took advantage of the foreclosure market in Phoenix in early 2008, while the CAD was on par with the USD. So far it has been a great decision simply because the CAD dropped 20%, and as a result our properties increased 20% thanks to the currency exchange alone.
My question to you, Greg, is what are your thoughts on holding US real estate (they are rented out) during this “transition” period? I think we should hold on and weather the storm, but then, I have the other side of me concerned about a prolonged hyper-inflationary period.
Thanks for the article and Merry Christmas!
The problem with having gone into the market early 208 is that I believe time will show you were in at least a year too early. While you made 20% on the currency, prices of real estate there have dropped substantially, and there is likely more decline to come.
Assuming you bought really well (say 20% below the market value at the time), but the market’s declined 20% since then, that means your net return is 20% due ONLY to the currency hedge. You would have been better converting CDN dollars into US dollars and sitting on the cash.
Having said that, what to do now?
You have 2 questions to answer:
(a) what do you expect the US $ to do next year and beyond?
(b) what do you expect Phoenix real estate values to do next year and beyond?
My personal opinion is that the US dollar is going to decline, AND the real estate values in Phoenix will not recover in the near future.
That means if I’m right, and you continue to hold your real estate, not only will you lose money on the currency as the US dollar-demoninated real estate drops in value, you’ll also lose the currency benefit. If the US $ goes to par against the CDN $, you’ll take a 20% hit on that, never mind the real estate value decline.
I do believe that hyper-inflation is in the future of the US, but I don’t see it happening for at least a year or two. A lot can happen between now and then. Holding an asset with a near term risk of loss of 40% in order to “hope” to benefit from long-term hyper inflation doesn’t make sense to me.
If you really believe hyper inflation is coming, then the most logical approach would be to sell all your real estate, buy physical metal, and wait for the hyper inflation. Gold and silver will likely do better than almost all asset classes in a hyper inflation environment.
Of course, this negates the issue of pay you pay if you sell now, etc.
You’re probably sorry you asked now! 🙂
Hi Greg,
Thanks for your response! And I’m happy I asked lol. That is exactly what I’ve been looking at. As my first option I think that I’ll try my luck and get US financing… perhaps the rules have changed since earlier this year (they wouldn’t lend to any foreigner). If that doesn’t work out I’ll have to weigh the other options.
Thanks again for your response, Greg 🙂
Am in the same position as Alberta Guy. Thanks for asking the question, AG. Bought in middle of 2008. Did not like the answer but have expected it. Thanks Greg for the honest outlook. Question is now how to sell them?…:))
I am also in the same position as Alberta Guy and KK Chan. Currently the property is doing well as I have a line of credit here in Canada and paid a substantial amount down as cash as I could find no other good investments at the time. The values in the area South of Phoenix have remained quite steady so the value does not appear to have decreased but the CAD has certainly lost a lot of ground to the USD. The dilemma I am facing right now is what to do.
1) Refinance in the US to pull a big part of the value back into CAD which could pay back most of the Canadian investment essentially making the original purchase almost free.
2) Sell the property and get it all back and take my small profit and figure what on earth to do with the cash.
3) Leave it as is and enjoy the low percentage line of credit in CAD.
The bigger question is what will the CAD do if the USD starts dropping?
Will the CAD actually potentially sit well above the USD?
Would our economy not fail in a situation like this and would the BoC not just try to follow the US down along with many other currencies dependent on the USD?
Can the purchase of a property for about $55/sqft in the Phoenix area drop much more as it hasn’t really in the past 6 months?
The “professionals” seem to think prices or real estate in Alberta and BC are going to drop like stones over the next year as Canada heads into a recession so is that a fair assumption or would you recommend buying in Alberta? I know many people who have purchased in Alberta at the same time I purchased in the US and they have seen some significant declines so I am curious what you think as I know you have some really good insight and the more information I have to make my decisions will help in the coming weeks. Thanks!