Benson's Economic & Market Trends
"Borrow and Run from the Dollar" - The Fed's Investment Opportunity
October 17, 2003
Short term interest rates have dropped to a 45 year low at a time when tax revenues, as a percent of GDP, are at a 44 year low; budget deficits are exploding upwards; the economy still has capacity utilization under 75% and the delightful increase in corporate profits are from cost cutting not revenue growth or the need for new investment. Indeed, there is virtually no return on capital investment in this country. If there was a return on capital, new factories would be built here in the U.S., not in Asia. The return on capital in Asia comes from substituting cheap labor for American labor, and selling back into America.
There has been a recent return to speculation in the U.S. fueled by the Fed's easy money policy, which has helped the stock market rise and keep cash from the mortgage market flowing into consumption. However, the U.S. needs to import about $1.5 Billion a day of foreign capital to balance U.S. capital deficits. Foreign central banks, particularly in Japan and China, are buying unprecedented volumes of U.S. Treasury and Agency securities to moderate the fall in the dollar. Without this creation of new "foreign money", the dollar would go into "free fall".
The high level of American stock and bond prices are clearly artificial and held up because of the creation of new money by the Fed and foreign central banks. The one thing that seems virtually certain is a decline in the dollar, but the question remains how much will the dollar fall and when will the dollar roll down the hill or just fall off the cliff?
If U.S. stocks are, indeed, back in a bubble along with real estate and bonds, and cash yields remain at around the 1% level - which is well below the rate of inflation - it does leave the investor in a quandary about what to do. The Fed is actually offering investors a simple solution that has worked well for many other countries over the ages - borrow money for next to nothing and get it out of the country! The average American, however, just isn't used to this strategy.
Typically, the strategy used by Latin Americans and developing countries was to borrow dollars from banks and the IMF and then use the money to purchase condominiums in Miami. With the dollar going down, they should be borrowing dollars but buying villas in Spain, rather than condos in Florida. The rest of the world knows about profiting from capital flight " didn't George Soros make a few billion dollars betting against the pound? At least it seems the smart hedge funds are beginning to catch on and gear up here in America.
This is how the "flight of capital" opportunity works: Just a few years ago when the dollar was rising, one could go to Japan and borrow Yen for almost 0% interest. The Yen could be used to finance U.S. securities, such as Fannie Mae mortgage backed securities. The investor could then lever his equity 20 to 1. In addition, not only would the investor earn the "carry" of the interest rate on the securities, less "the cost of carry" (which was almost zero), but gain from the appreciation of the dollar! The returns were huge and for some funds they were over 100% on invested capital!
Now, the U.S. investment world is "upside down" and the game works in reverse. The Fed allows speculators to borrow dollars at 1%. With the dollar going down, just about any financial or real asset in any decent foreign country will go up in value in dollar terms. With the Fed holding interest rates below the rate of inflation (and most foreign interest rates are above rates in the U.S.), borrowing cheap and getting dollars out of the U.S. and turned into something of value, clearly offers a better return than investing in U.S. factories, stocks or bonds. When you notice that America is committed to running the largest trade deficit in history, and raising its budget to 5% of GDP, the economics get much better!
The dollar should depreciate at least 20% against major currencies, and much more against select currencies. Fortunes will be made, or at least saved, by investors who can get their money out of the U.S. before foreign central banks slow their dollar buying.
If you have a few million dollars to protect, you should be in a position to find a hedge fund that can borrow a few billion from your local money center bank, and run a major sophisticated foreign asset position. If you are a small investor, there are still some things you can do. It is possible to open foreign currency accounts offshore. (If you do open a foreign account, however, you must inform the IRS when you file taxes because Big brother needs to know!) For instance, HSBC does offer a Euro account to American citizens out of the Channel Islands. Moreover, Everbank (www.everbank.com) offers U.S. bank deposits in foreign currencies that are FDIC insured.
When making investment decisions, you should consult with your financial advisor but please know that certain stocks, such as silver and gold, may benefit from both the drop in the dollar and the likely rise in inflation from the double dose devaluation and easy money policies.