Why the U.S. Wants the Dollar to Fail

Today's comment is by Jack Crooks, Editor of World Currency Options and President of Black Swan Capital.

Dear A-Letter Reader,

Imagine that you have US$2.8 trillion sitting around. And for kicks, let's assume that most of that money, about two-thirds, is invested in U.S. dollars and other dollar-denominated assets like U.S. Treasury bonds.

And let's assume that your currency was linked to the U.S. dollar, too. In other words, you often buy dollars to maintain a stable value relative to the buck.

As long as the dollar is doing okay, there's no problem. But what if it's falling, as it has been over the last few years?

You might decide to no longer peg your currency to the dollar. That solves the problem of tying your monetary policy to a boulder rolling downhill.

Of course, your decision also means your US$2.8 trillion in dollar-denominated assets will get hammered in the process!

Okay, you say, I can just sell off a lot of those assets to avoid the losses. The problem is that it's not easy to unload such a huge amount of investments without the market realizing what you're doing. And when they catch wind of your plan, they'll sell too. Thus, the price will fall even faster!

It's a real Catch 22. And you know what?

This Is Precisely the Situation China
And the Gulf States Find Themselves In!

Between them, China and the oil sheikdoms are sitting on an estimated US$2.8 trillion in reserves. It's all thanks to huge trade surpluses and massive oil revenues.

For the sheikdoms, their currencies are still pegged to the dollar, so their currencies depreciate right along with the U.S. dollar. Meanwhile China already pegged their currency to a “basket of currencies” in 2005, so the yuan isn’t completely dependent on the U.S. dollar.

But China still has a major dependence on the U.S. economy (not to mention all those dollars they still hold in reserve).

China doesn't want to kill the U.S. consumer. That would hurt its export growth, which is still the primary driver of the Chinese economy.

Meanwhile, the Gulf States - OPEC rhetoric aside - understand that any global financial turmoil created from a falling dollar will hurt their own investments and could mean lower prices for crude oil.

So, here's the US$2.8 trillion question: Will the Big Dog among the Gulf States (Saudi Arabia) and the Big Dog on the global economic stage (China) completely abandon the dollar?

I don't think so.

They have more to lose than gain if they cut their ties to the buck. It's simple self-interest! And I believe the U.S. Fed and Treasury know this. In fact, I believe they have an implicit policy in place to placate these Big Dogs. I'll get to that in a moment. First, I want to be clear on one important fact.

The Dollar's Decline Is Not Over
It Will Just Remain Orderly!

Even if China and Saudi Arabia don't abandon the dollar, as far as the markets are concerned, the very idea that they could is problem enough.

And until we witness a real fundamental improvement in the factors that are most important to the direction of the buck - economic growth and interest rates - these bad news scenarios will reign supreme.

You see, in the currency game, perceptions are what matter most.

So as you listen to the daily chitchat and read the flow of news concerning the dollar, keep in mind there is a lot that goes on behind the scenes that we are not, and never will be, privy to.

The best you can do is piece together words and actions to discern implicit monetary policies. Consider all public statements by policymakers as either window dressing or efforts to subtly advance their predetermined policies.

Why on Earth Would the U.S.
Want the Dollar to Fall?

Here's how I think the current argument goes:

The U.S. wants nothing more than to keep global growth humming. In order for global growth to remain on track, they know that China has to keep going gangbusters.

And for China to continue thriving, they know that Mr. and Mrs. U.S. Consumer must continue shopping. That's because they're still the biggest buyers of China's exports.

Thus, everything still hinges on U.S. consumers!

The Fed knows that lowering interest rates is the best way to support domestic shoppers. Lower rates make it easier for people to keep borrowing and buying.

As happy side effects, those lower interest rates also:

• Make money cheaper to borrow and readily available for investment speculation
  
  
• Push the value of the dollar lower, which makes things like U.S. stocks look cheaper to foreign investors
  
  
• Allow large multinational U.S. companies to translate foreign sales back into more dollars

The sum total of these three forces is that U.S. stocks are likely to go up. That's great since higher stocks also makes U.S. shoppers feel wealthier and more likely to spend, spend, spend.

Let me explain ...

We all know U.S. housing prices are falling off a cliff. That can have a major impact on consumer spending, as people who are losing money (even on paper) are less inclined to hit the mall.

BUT, the stock market is also rising and pushing up the value of just about every consumer's 401(k). That goes a long way toward making them feel better about their spending habits.

Voila! A rising stock market is an excellent way to counter the negative wealth effect from falling housing prices.

So, you see, lower interest rates and a lower dollar go hand in hand. What's more, they actually form a self-reinforcing cycle...precisely the kind of cycle that the U.S. wants right now.

Bottom Line: Your Money Gets Less Valuable,
But All the Big Dogs Stay Happy

China benefits as the U.S. consumer stays in the game.

Saudi Arabia benefits by selling more oil, at high prices, as global demand remains intact.

And the U.S. economy benefits as exports rise and its assets look increasingly cheap to international investors.

Who knows, one of these days, even U.S. real estate prices might look cheap to big investors holding euros, pounds, Australian or Canadian dollars.

Of course, in the meantime, the paper in your wallet will keep shrinking in value, and a lot of currencies will continue gaining against the greenback.

So the best strategy is staying on the side of the currencies that have the momentum. That's the best way to protect yourself throughout the dollar's orderly decline.

JACK CROOKS, Editor
World Currency Options

EDITOR'S NOTE: To find out which currencies have long-term momentum - and how you can invest in them for a possible double or triple-digit gains - Click here.

Insurance Companies Jump Head
First into the Sub-Prime Fray

Why are some insurance companies invested in mortgage-backed securities? Why did E*Trade pile into sub-prime lending and mortgage-backed securities?

Increasingly, we're learning that non-bank companies have delved into the opaque world of mortgage derivatives and CDOs, or collateralized debt obligations.

In an effort to boost their earnings, these and many other companies in the financial sector have lunged after mortgage securities. The irony is that most of these institutions don't really understand what they own. Also, since late July, they can't even get a decent bid to sell these securities. That puts more pressure on the mortgage-backed market. And it's causing more selling and broad based panic.

Look How Far Insurance Has
Plummeted Since October

Swiss Re (RUKN.VX), the world's largest insurance company, just announced a US$1 billion loss on mortgage-backed securities last week. Just a few months ago, the Swiss carrier claimed their books were clean. So this was a huge shock to many investors.

Surprise! Markets took Swiss Re's shares 10% lower in Zurich in just one day. They now sit at a 52-week low. The sub-prime shock spilled over to all insurance companies last week with the good, the bad and the ugly all going down hard.

As I've said before, previous financial crises like the Japanese banking crisis took years to materialize before actually peaking. The sub-prime mess, which began in earnest last February and resurfaced like a bad dream in July, will probably stay with us for at least another six months.

Financial companies have not been honest with shareholders up until now. They should fess-up to their mortgage-backed losses. But part of the problem is that many banks and now, insurance carriers, can't sell these illiquid securities because the market is almost frozen.

Financial services are a big chunk of the global stock index. The protracted selling is still quite severe and won't end until the market has a real handle on the cumulative amount of losses.

And I don't see companies reporting their total losses until they can figure out what these securities are worth. It's not over yet.

ERIC ROSEMAN, Investment Director

P.S. As the financial and insurance sectors come unraveled, my colleague Mike Burnick is cleaning up with huge profits for his Market Shock Trader subscribers. While you were planning your Thanksgiving feasts over the past few weeks, his subscribers were cashing in on this economic bloodbath with gains of 107%, 117%, 131% and 142%! Click here to learn the secret behind these big winners!

Privacy & Rights

Hushmail Keeps Your Email
Anything But "Hush Hush"

Recently, U.S. investigators forced Hushmail, a leading provider of email privacy solutions, to divulge copies of decrypted, "plain text" email messages.

At the time, it appeared only one form of Hushmail encryption was compromised. But I've now learned that the company has developed techniques to eavesdrop on all users, in response to a valid court order.

A little background: in 1999, Hushmail, based in British Columbia, Canada, introduced a revolutionary service to make sending and receiving encrypted emails easier and faster. Hushmail allows users to send and receive encrypted email messages through an Internet-based interface similar to Yahoo! or Hotmail email.

The original - and supposedly surveillance-proof - encryption "engine" works by sending your PC a Java "applet" that performs the encryption. Since the encryption occurs on your PC, Hushmail supposedly has no access to unencrypted messages.

Indeed, Hushmail promoted this capability by stating:

"Not even a Hushmail employee with access to our servers can read your encrypted email, since each message is uniquely encoded before it leaves your computer."

Loading a Java "applet" takes a few seconds and delays access to a Hushmail account. Some Hushmail users didn't want to wait. So, in 2006, Hushmail developed a service that didn't require the applet. In this service, encryption occurs in Hushmail's own servers, not in your PC.

This introduced an obvious vulnerability, which Hushmail confirmed earlier this month. The company announced that in response to a Canadian court order, it had turned over 12 CDs worth of plain-text email messages to U.S. investigators.

It now appears that Hushmail can send a "poisoned" applet to subscribers using the original, Java-based service. That applet sends the targeted user's passphrase back to Hushmail. Thus this gives investigators access to the "plain text" of all stored emails and any future email sent or received. Again, this evidently occurs only after Hushmail receives a valid court order requiring it to turn over plain text messages from a targeted account.

According to Brian Smith, Hushmail's Chief Technology Officer, "The extra security given by the Java applet is not particularly relevant, in the practical sense, if an individual account is targeted."

Hushmail remains preferable to the alternative followed by 99.9% of email users - sending unencrypted messages in "plain text." Reading these messages is remarkably simple. Email also has less legal protection than telephone calls, particularly with regard to messages stored in an Internet-based system.

However, if you're seeking stronger protection, encryption programs you install on your PC, such as PGP, are superior to Hushmail. PGP isn't immune to attacks (e.g., an investigator might plant "Trojan Horse" software to steal your encryption keys and passphrase). But, when properly used, it offers an extremely high level of security.

MARK NESTMANN, Privacy Expert & President,
The Nestmann Group
www.nestmann.com

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