Two Stocks I Like – Alternative Energy

Although people continue to debate the existence of global warming, good investors should leave the debates aside and focus on reality: demand for alternative energy has risen significantly in recent years, and will likely continue to do so. Clean energy solutions are more practical and cost effective than ever before, and industry is embracing the savings and public relations improvements that clean energy offers.

Two companies that stand to gain large amounts of new business as demand for alternative energy increases are the well-known companies General Electric and Dow Chemical (I own both).

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General Electric (GE) is one of the largest companies in the world, and the only remaining original component of the DOW 30 Index. It is a technologically sophisticated company with diverse fields of business, giving it an annual GDP larger than the entire country of Israel. GE is a leader in (among other things) nuclear power generation, wind turbines, hydroelectric power, and components for many sources of alternative energy.

GE suffered during the credit crisis of 2008 (especially due to the investment arm GE Capital), and although the stock has come back 100% from its lows it is, in my opinion, still selling well below its true value.

GE Statistics (at time of writing):
Price $18.30 USD
P/E 18.15
Return on Equity 10.11
Dividend Yield 2.19%

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Dow Chemical (DOW) was incorporated in 1897 and now employs over 52,000 people. DOW is already a huge supplier of residential and commercial insulation and weatherization products (including the ubiquitous Styrofoam®), and is always working on new and innovative energy-saving solutions. In 2009, Dow introduced solar shingles. Dow is also currently developing advanced Carbon Dioxide scrubbers for commercial use.

Dow stock has tripled since its low in 2009 in anticipation of the return of substantial revenue, giving it a ridiculously expensive-looking P/E ratio of 93. Nevertheless, DOW has incredible revenue generating capabilities, and I believe that in a few years today’s price will look like it was a bargain.

DOW Statistics (at time of writing):
Price $18.30 USD
P/E 93.2
Return on Equity 3.16
Dividend Yield 2.00%

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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

Alternative Energy – Cap and Trade

You’ve heard about Cap and Trade, but what is it?

Before talking about Cap and Trade, one first has to understand pollution control. Note that I am using the term “pollution control” (a tangible, measurable phenomenon) as opposed to “climate change” (a debatable, difficult-to-measure phenomenon).

When talking about pollution control, one has to be sensible. Americans are not going to park their cars and start cycling to work any time soon. On the other hand, it doesn’t make sense to drive your SUV two blocks to buy milk, either. Any good economist will tell you that to control pollution you have to control behavior. This means either putting incentives on green, putting disincentives on brown, or both. And you have to do it without killing the economy.

Say that you own a company that produces 1 tonne of pollutants per day of production. If you were to build infrastructure to reduce that pollution, it would cost you $50/tonne. Since there is a cost with no equivalent savings, there is no inventive to implement pollution control measures. But, if the Government were to start fining you $60 per tonne of pollutants, suddenly there is an incentive not to pollute: your company saves $10/tonne to build the anti-pollution infrastructure. The point is, while free market economics takes care of most issues of industrial production, pollution is rarely one of them. Pollution control has to be mandated.

Measures that have been already been used to control pollution include taxes on gasoline, emissions taxes for corporations, tax credits for buying low-energy home appliances, banning polluting substances (such as DDT and CFCs), and rebates to convert gasoline vehicles to natural gas. So how about Cap and Trade?

Cap and Trade -- also known as cap-and-tax by those who oppose it -- is the name given to a system where a central authority (ex. Government) sets a limit on the amount of pollution that can be emitted. Companies are issued credits, giving them the right to produce a specific amount of pollution (that is reasonably low). If they are efficient (pollute less than their allowance), they can sell their excess credits to other companies for cash. If they are inefficient (pollute more), they need to buy credits from other companies to avoid heavy fines. In other words, there is an economic incentive to meet pollution targets and become more efficient. In theory, it’s a good idea.

The problem with Cap and Trade is that it is complicated and easy to manipulate. If a company manufactures energy-efficient camp stoves, for example, and sells them to African villagers to replace their dung-burning stoves, should they be able to claim credits? If they plant a forest of trees, should they get credits? If a fire destroys the forest, should the credits be taken away? It’s all very opaque. This is not to mention the potential for corruption when big businesses trade credits for cash. And, who decides how many credits to give out, anyway? Will the amount of credits issued rise during an economic crisis, so that businesses can save money?

In my opinion, the best solution is to keep doing what we are already doing. When I visited California as a kid, the smog was so thick it literally made my eyes water. After California passed a law requiring low-emission mufflers, the smog cleared up. When I visited England as a child, households burned coal for heat and buildings looked filthy. Since the government expanded the infrastructure for natural gas and gave incentives to switch, the same buildings now look pristine. When my mother was a child, DDT was a common pesticide. After it was determined to be dangerous, DDT was banned.

The American Clean Energy and Security Act, now in Congress, includes many elements similar to those that have already proven successful; for example, increasing standards of energy efficiency for buildings, modernizing the electrical grid, giving incentives for energy efficient appliances, and requiring large utility companies to obtain some of their energy from renewable sources. But Cap and Trade is also a primary element of the bill.

Cap and Trade isn’t a terrible idea, I just don’t believe it is the best idea. Contrary to some news reports, most major companies support pollution control: it is good for public relations as well as the environment. But they want the playing field to be fair. Existing pollution control measures work and should be expanded. The Cap and Trade portion should be removed and replaced with carbon control measures, tailored to local areas and individual industries.

U.S. Robin Hood Real Estate, Part II

In last month’s U.S. mortgage refinance program, the Democrats announced a comprehensive plan to help struggling homeowners. The plan allowed homeowners to refinance to a longer amortization (ex. 35 years) or reduce their interest rate in order to make monthly payments more affordable. This Friday’s announcement went one step further, allowing homeowners to actually reduce the amount of principle they owe (ie. write off the debt). In essence, the plan is a mass Chapter 11, funded by the taxpayer.

With this new plan, the home equity gamblers of 2005-2007 have really hit the jackpot. Although they lost equity in the real estate casino (which they chose to enter), the owner of the casino is now handing them their money back. Meanwhile, prudent people who didn’t gamble remain in apartments or living with their parents, driving compact cars instead of SUVs. It’s a deplorable affront to dignity and consequence.

In my view, if the big banks want to modify their mortgages to prevent further losses, they should be encouraged to do so; taxpayers, however, should have no part in it. Painful as it may be, let supply and demand work itself out, and let personal consequences matter.

See also Part I
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“The house doesn't beat the player. It just gives him the opportunity to beat himself.” Nick Dandalos, professional poker player

The World Housing Bubble

The title of this article is a bold statement…world housing bubble.

The near-failure of the U.S. economy in 2007 brought with it the ultimate Keynesian response: extremely low interest rates, all across the globe. Shockingly, although countries lowered their rates in response to a real estate collapse in America, the result has been bubble-like housing growth all over the world.

Consider this selection of recent articles…

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CHINA

Overseas realty proves safer bet
“More wealthy Chinese are buying overseas properties for better investment returns as skyrocketing property prices in the country makes domestic home purchases more risky.”

www.cs.com.cn/english/ei/201003/t20100322_2373066.htm


AUSTRALIA

House surge leads to mortgage stress
“VICTORIA'S resurgent housing market is putting borrowers under severe financial strain, even if they are employed or earn more than $80,000 a year.”

www.news.com.au/money/property/house-surge-leads-to-mortgage-stress/story-e6frfmd0-1225843130252


CANADA

House prices to hit record: Scotiabank
"Canada's housing boom will continue this spring as exceptionally low mortgage rates and the expectation that borrowing costs will soon be headed higher – add a sense of urgency to consumer buying."

www.theglobeandmail.com/report-on-business/economy/house-prices-to-hit-record-scotiabank/article1509303/


ISRAEL

This bubble won’t bust, if we build over the Green Line
"The great crisis in the financial market drove people out of financial assets while historical low interest rates made mortgages much cheaper. The feeling that the only safe assets are the old-fashioned ones, first and foremost solid buildings, combined with a wave of foreign Jewish investors rushing to buy homes in the land of the Jews as a kind of an insurance policy drove the prices of homes in Israel to the top."

www.jpost.com/Business/BusinessFeatures/Article.aspx?id=171505


SOUTH KOREA

Housing Market Bubble possibility not high nationwide
"A KCCI representative commented that 'although there are many ongoing debates about the possibility of housing bubble...the possibility of house bubbling is quite low,' and further added that 'we must rather focus and prepare ourselves for the possibility of sudden drops in house prices due to unstable economic situations.'"

english.korcham.net/bbs/viewnotice.asp?code=reports&page=1&id=460&number=460


U.K.

Fears grow that new mortgage drought could hit house prices
"House prices fell 1.5 per cent in February after seven months of uninterrupted growth, according to the Halifax, the UK’s biggest mortgage lender. It says that buyers were deterred from visiting estate agents by the severe cold weather and changes to stamp duty."

www.timesonline.co.uk/tol/money/property_and_mortgages/article7060101.ece


LEBANON

Salameh rules out any real estate bubble
"Central bank Governor Riad Salameh said on Thursday that he does not expect a real-estate bubble to take place in Lebanon, and that the surge in property prices in the country is due to a real increase in demand."

www.beirut-online.net/portal/article.php?id=6669


SWEDEN

Economists reject 'housing bubble' report
"Economists from state-owned mortgage lender SBAB have rejected as unfounded warnings from the National Housing Credit Guarantee Board (BKN) that Sweden stands on the precipice of a house price crash."

www.thelocal.se/25236/20100226/

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The worldwide economic recovery, which is only now taking shape, is threatened by the very thing that started the crisis in the first place: real estate. Only this time it doesn’t just involve a single country.

The world's economies are in a dangerous position. On one hand, increasing rates could slow down or even derail the recovery. On the other hand, the longer interest rates stay low, the more unsustainable long-term real estate prices will become.

Somewhat perversely, the U.S. economy seems to be the real winner here. After two years of suffering, U.S. banks have recapitalized and are sitting on cash; home prices are affordable; consumers have been paying down debt. Although the U.S. economy looks ragged at the moment, it is in the best position to move forward.

One can only hope that the world real estate reversal will be more anticipated, more orderly and more methodical than the earlier U.S. meltdown: yet somehow, I doubt it.

Investors can do some simple things to prepare for the inevitable. First, take some profits and build cash. That does not mean selling all your stocks, for heated markets can rise for much longer than you may think. It does, however, mean selling parts of your portfolio related to housing and construction. It also means making sure that if you have a margin trading account, you are using margin sparingly, if at all.

Most importantly, be vigilant -- which includes checking this website from time to time. When the “things have slowed down but are still fine” headlines start making regular appearances on the news, it’s time to start considering making money on the downside.

As manias subside, the result is never pretty.
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"When money is free [interest rates are lower than inflation], the rational lender will keep on lending until there is no one else to lend to." George Soros

America Wasn't Ready

This Sunday, the U.S. health care bill was passed after a furious battle.

The center and left were virtually silent this week, giving the limelight to those who believe that Barack Hussein Obama is not working in their best interests, to say the least. In fact, the opposition united in what both looked and sounded like a religious crusade to save America.

“We have to deny the power of the devil and his disciples in our midst,” wrote one blogger. “Pray to the father God to wake up Congress,” pleaded another. References to “rebuke,” “wickedness,” and “righteousness” were everywhere.

Then there was the coming revolution. There were calls for “bloodshed” if the bill was passed, for “revolution in the streets,” and to “impeach the foreign born dictator.” Conservative talk-show host Rush Limbaugh said that Obama’s secret goal is to divide America before destroying it, while house Minority Leader John Boehner likened the bill to "Armageddon." An ad on the Washington Post's website offered free handguns and knives to those who enrol in a self-defense training course, to prepare you "for what's coming."

The conservative right says that their hatred of Obama is politically – not racially – motivated. Casual observation suggests otherwise. One commenter on a national news website called President Obama a “lying sack of Kenyan dog crap.” Another said that he “lies through purple lips.” Yet another said that the “monkey man will get beaten.”

Of course, the health care bill passed and will now become part of American life. Citizens will have health coverage, whether they like it or not.

For investors, the big question is “what to do now?” When propaganda is rampant & emotions high, what can investors expect? At the opening bell this Monday morning, the 22nd of May 2010, two possible scenarios could occur: A) The right will demonstrate its genuine belief that Obama has destroyed their economic future by selling off U.S. stocks like mad, creating one of the largest stock market crashes in history. Or B) nothing dramatic will happen, showing that it was all just crazy talk.

Personally, I’m hoping for “A.” If so, you will find me at my computer, happily buying underpriced stocks of great American companies, while everyone else loses their minds.
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“Reactance – the urge to do the opposite of what someone wants you to do out of a need to resist a perceived attempt to constrain your freedom of choice.” Wikipedia, “List of Cognitive Biases”

Thomas Malthus couldn't foresee this

In 1798, Thomas Malthus, in an essay on the principle of population, put forth the idea that "the power of population is indefinitely greater than the power of the earth to produce subsistence for man.” Ever since, people have been worried about the capacity of human beings to produce enough food to sustain their growing population. Yet, the data seem to indicate that the inevitable conclusion of Malthus’ theory – food shortages & starvation -- are a long way off.

Malthus could not have foreseen how modern farming methods have transformed the productivity of the farm. Machines have taken the place of farmhands, and computers have revolutionized the business. Farms are getting larger and productivity higher. In the last 30 years, for example, sow productivity (for pork production) has increased by 70%. With high protein diets, it now takes only 6.5 months for a piglet to become a 260-pound hog. Corn yields in the U.S. have increased from about 40 bushels per acre in 1950 to 150 bushels per acre today (U.S. Dept of Agriculture). Other farm industries are experiencing the same level of productivity growth.

Last year I had the opportunity to visit a state-of-the-art dairy farm in Canada. The whole concept of the farm is too maximize milk productivity by keeping the cows fat, happy, and pregnant.

The barn is divided into gated areas: one for milking, one for eating, and one for resting. Each cow has a radio controlled collar that limits the amount of time they spend in each area. When a cow has been in the feeding area, if it wanders near the gate of the rest area, the gate will open and allow the cow to pass. Once in the rest area, the collar will only open the gate to the milking area, and not back into the feeding area. Thus, the cows go from milking to eating to resting on a rotating basis.

The rest area consists mostly of “water beds” (that look like large yoga mats) for the cows to lounge on. If they get bothered by flies, overhead fans whisk them away. If their backs get itchy, the cows stroll over to the automatic back scratcher. Comfortable, low-stress cows produce more milk, so no expense is spared.

Once they become uncomfortably full of milk, the cows walk themselves to the milking area and their radio collars open the gate. In the milking area a laser scans the udder, and a robotic arm attaches the milkers. A computer interface keeps track of each cow’s production, analyzes the milk (and therefore the health of the animal), and sends the information to a central computer. Any minor problems, such as a non-milking teat, also gets relayed to the computer. The milk itself flows into a stainless steel storage tank. Once done milking, the suction cups detach and the cow is free to stroll back to the feeding area.

The farmer pointed out to me that in addition to keeping stats on the cows and opening gates, the radio collars also keep track of the cow’s movements. When cows go into heat, they get frisky and tend to pace. Thus, a spike in activity indicates a cow that can be taken out for artificial insemination. I asked if I could borrow one of these collars for my girlfriend, but the farmer basically ignored me.

All told, the farm is virtually self-sufficient. Once the cows know the process they do most of the work themselves. In general, farms are becoming larger and more businesslike.

In recent years, the trend has been to accept Malthus’ theory, and to believe that with the rise of India and China food shortages will soon become a reality. Long-only commodity index funds, which assume rising food prices, are popular. Yet, while theorists talk about shortages, the reality is that every year foodstuffs such as apples, peaches, hogs etc. are left to rot or culled to reduce gluts caused by overproduction and/or lack of demand. Other industries, such as sugar, milk, and Japanese rice production are heavily subsidized.

Thomas Malthus’ theory of population growth may become true some day, but not for a long, long time. Investments that assume a steady rise in food-related commodity prices are not, in my opinion, a good way to make money.
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“…cattle are ruminants, a term that refers not to their capacity for deep thought but rather to their distinctive ability to digest plant fibers.” Dunsby, Eckstein, Gaspar and Mulholland: Commodity Investing

That's a Fact, Jack

INVESTOR PSYCHOLOGY

Over time I have received many good pieces of advice about investing, but one of the simplest and best was, “learn to separate opinions from facts.” Whenever there is financial turmoil, emotionality reigns - and emotion is the mortal enemy of logic. Truths becomes distorted. Facts become obscured in the fog of opinion. To be a great investor, you must first filter these facts, and then form your own opinions.

To illustrate how easily opinions and facts can become obscured, I have included a few recent examples from the media…

- “Greek borrowing rates increased by as much as 10-15% as a result of speculation that Greece would default on its debt.” OPINION
- “A market frenzy in recent weeks saw traders make bets worth billions of dollars against the euro and on the chances of Greece not repaying its massive debts. FACT

- “Due to changes in fuel efficiency and the move to hybrid and electric vehicles, demand for oil will drop by as much as 25% in the next 5-10 years. OPINION
- “Most Americans, and an increasing number of Chinese and Indians, drive gasoline-powered vehicles to work every day.” FACT

- “World demand for oil will increase by 900,000 barrels per day this year.” OPINION
- “OPEC believes that world demand for oil will increase by 900,000 barrels per day this year.” FACT

Note that opinions often provide more specifics than truths, thus obscuring the fact that they are merely opinions (read that sentence two times fast)! Don’t be mislead. Read every news story with a skeptical eye. Think, “How could this article be wrong? Do the facts (if any) support the conclusion? If it seems logical, what could derail it?” Recognize that correlation does not imply causation. Recognize that taking an opinion contrary to the crowd does not necessarily make it right. Then, after reviewing the data, form your own opinion with a blatant disregard for everything you just read – except, of course, the facts.
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"You can't do well in investing unless you think independently. And the truth is, you are neither right nor wrong because people agree with you. You're right because your facts and reasoning are right." Warren Buffett

Spin City

In recent days, both the Canadian Real Estate Association (CREA) and the Canadian Mortgage and Housing Corporation (CMHC) have been coordinating the same message to potential homebuyers: sales have dipped slightly, while listings & housing starts are rebounding, which is leading to an “improved balance between demand and supply.” The result, we are told, will be stable or modestly increasing home prices, simultaneously proving that the bubble everyone was whispering about was false. We can all breath a sigh of relief, and go out to buy that condo.

Personally, I find this spin-doctoring offensive. The CREA argument about supply and demand is rather like arguing that the Nasdaq was not overpriced in 2000, since there was a balance in demand for Internet stocks. In fact, one characteristic of bubbles is that demand suddenly plummets when people realize that there is no one left who wants to buy. So, to know the real story, we have to talk not about supply and demand, but rather about valuation.

By financial standards, a home is considered “comfortably affordable” if monthly mortgage expenses are 32% of pre-tax monthly income or less. As this number increases, one’s standard of living becomes increasingly tenuous. When monthly debt payments reach 40% or more of income (including mortgage payments, car payments and others), financial survival becomes a struggle.

The facts about Canadian housing are straightforward. According to RBC research (November 2009), if a median-income family bought an average 1200 sq ft bungalow in Canada, their monthly payment would be 40.2% of pre-tax income -- well above the 32% recommended, and in fact already above the monthly limit for total debts. In major cities, the numbers look even worse. In Toronto an average home requires 48.6% of pre-tax income: in Vancouver, 66.8%. This effectively means that if an average couple bought an average home in Vancouver, they would pay their income taxes, make their mortgage payment, and have nothing left.

And, the above statistics are the case today. Canadians, normally known for financial prudence and common sense, have actually been increasing their personal debts – not paying them off -- since the credit crisis began. The Bank of Canada stated that, “overall risks to financial stability arising from the household sector have continued to increase.” If current interest rate and savings estimates remain unchanged, Canadian debt payment levels will reach record highs by the fourth quarter of 2011. By the middle of 2012, roughly 1 in 10 Canadian households will have debt payments that leave them “financially vulnerable.”

In order for home prices to remain at current levels, one of the following must occur:

A) All homes and condos built from this point forward must be bought by foreigners/immigrants (since locals are already incapable of safely purchasing homes at today’s prices).
B) Wealthy investors must buy -- and continue to buy -- multiple homes for speculation, and keep them for years.
C) Wages in major cities must increase by approx. 8-30% (depending on the city) within the next 12 months, with no rise in unemployment.
D) Home prices must drop.

I can’t blame the CREA for their rosy interpretation of the numbers; after all, their mandate is to represent “more than 98,000 real estate Brokers/agents and salespeople working through more than 100 real estate boards and Associations.” With such allegiances, it seems unlikely that the CREA would ever say, “we think homes are overpriced and that you should wait to buy one.” Still, for the CREA to pooh-pooh the notion of a real estate bubble by citing supply and demand is either foolhardy or immoral.

Ockham’s Razor states that for any given problem, the simplest explanation is generally the best one: Canadian home prices must drop. For the record, my educated guess (it is only a guess) is that this drop will begin sometime between the 3rd quarter of this year and the 4rth quarter of 2011. And it will be nasty.
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“There is virtually no risk of a national housing bubble based on the fundamental demand for housing and predictable economic factors.” David Lereah, former chief economist of the National Association of Realtors, 2005 U.S.A.
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The Fate of the U.S. Dollar

Fears of a “great fall” in the US dollar are widespread, and with good reason. US Government debt took on ghastly levels during the credit crisis. China has threatened to stop buying US debt, partially because of valuation concerns and partially because of politics. OPEC has threatened to change to an alternate currency for the trade of oil if the US dollar continues to lose its value. The saber rattling is intense, and the statistics look grim. But will the “great fall” occur, and if so, when? To find out, we need to fully explore the facts, and their relationship to the dollar.
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FACTOR 1 - Foreign Ownership and Trade Deficit

A current account deficit (when a country imports more than it exports) is a regular feature of the US economy. As long as the US is paying more to foreign countries than these countries are paying to the US, the US$ will continue to slowly decline. There is talk that because of this uncertainty OPEC and China are both considering moving away from investing in US dollars. The problem with this story is that there is no other currency that will suffice. The Euro has its own share of problems, with member countries having high debt levels. The Canadian $, Australian $ and other currencies cannot support the level of trade necessary. The US$ is, at present, still the only logical choice for International trade.

Direction –Short-term Neutral, Long-term Bearish

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FACTOR 2 – The U.S. Economy

At present, the world is rife with bubbles. Canada, China, and to a lesser extent the U.K. are experiencing housing bubbles. China also has a stock market bubble. Gold is firmly in fear territory. Paradoxically, what is usually the safest of the safe (T-bills and gold) are now amongst the riskiest.

The US economy, on the other hand, is in good shape for the future. Major asset bubbles have already burst. Unemployment is high but stabilizing. Home prices are already low and getting lower, to the point where an average-income family (with good credit) can once again comfortably afford an average home. Citizens are, for the first time in years, paying down their debts and saving. The banks have recapitalized and have greatly reduced their leverage. In short, the U.S. has experienced a great deal of pain, and is now trudging slowly toward recovery. This recovery is likely to firm at the same time as other bubbles in the world begin to burst.

Direction – Short-term Bullish

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FACTOR 3 – Demise of the Carry Trade

For the past two years, financial institutions around the world have taken advantage of low US interest rates, using the US dollar for “the carry trade.” The carry trade is the name given to taking out loans at low interest rates, and using these funds to invest in higher interest investments elsewhere (often in another country). For example, say a hedge fund in Singapore takes out a loan in US dollars. It may then convert the funds to Euros and invest the money in a German bond that pays a higher interest rate than the rate on the US loan. The result is “free money” to generate income.

Because of the carry trade, many US dollars have been sold (converted to other currencies). When the Fed starts raising interest rates, the US$ carry trade will reach a point where it is no longer profitable and hedge funds will have to pay back their US loans. That is, once US interest rates begin to rise, there will be a rush to exchange foreign currencies for US dollars to pay back loans, boosting demand for the US$ and therefore price.

Direction – Short-term Bullish

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FACTOR 4 - US Debt

The US, during the credit crisis, built up a huge amount of debt. Many worry that this will give the US an excuse to print money and debase the currency (since it’s better to pay back debt with dollars that are worth less). This reasoning is faulty for two reasons: the nature of the debt, and relative value.

Although the Government spent a lot of money during the credit crisis (and before it), the amount of money spent is of little relevance. What is relevant is the return on capital. That is, for every dollar spent, how much economic prosperity will that dollar create? Spending on such things as education and infrastructure (roads, communications) is important not only because it creates jobs immediately, but also because it leads to greater economic prosperity later on (rather like spending money on a University education). The recent spending spree may or may not create a good long-term rate of return – the verdict is still out.

Many people believe that the money the US Government leant to banks is “gone.” That is, that it was given to the banks and they spent it, and that it will now take years for them to pay it back. This is nonsense. Money was given to the banks because banks are required to keep a certain level of collateral on their books in order to operate (known as a Tier 1 Ratio). The money given to banks was simply deposited into the bank’s accounts so that they met the requirements to continue banking and giving out loans. Of the 2 trillion dollars given out for liquidity during the credit crisis, all but 100 billion has already been repaid, and the Fed fully expects the rest to be paid back sooner rather than later. The US taxpayer has not lost a dime in this endeavor.

Relative value is the fact that currencies are valued compared to each other. Although the value of the US dollar has dropped relative to, say, gold, it has retained reasonable stability relative to most other currencies. This is helped by the fact that Europe, Dubai, Canada etc. have recently run up their debt levels just like the US has (or worse). So, while US debt may be a matter of concern, it isn’t necessarily a concern for dollar valuation. In this regard, it is notable that whenever bad headlines hit the news, the US dollar rallies: that is, when trouble strikes, investors from all over the world still seek the safety of the US dollar.

Direction – Short-term Neutral, Long-term Unknown

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In conclusion, although US debt levels and trade imbalance are matters of concern, the short- and medium-term case for the US dollar is strong. The US is on the road to recovery, effectively two years ahead of the rest of the world. And, when the Fed begins raising interest rates the carry trade will collapse, urging the US dollar up.

Though the long-term crystal ball remains cloudy, the imminent demise of the US dollar has been greatly exaggerated.

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“The commodity value of the circulating media (paper money) is zero.” Binhammer and Sephton: Money, Banking, and the Canadian financial system.