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Why the US dollar party may yet end…

… And why the Singapore dollar is the investment holding currency of choice

FOR all the foolish chatter about an ‘unprecedented’ meltdown, the ongoing CDO (collateralised debt obligations) crisis is but a re-run of a regular occurrence in the banking industry: that of a cycle of extremely poor credit decisions by professional lenders, in this case matched by extremely poor investment decisions by professional investors.

Common in the emerging markets, that this happened in the world’s richest and most developed economy in the era of sophisticated Basel II credit risk standards speaks volumes about the triumph of hubris in American ‘sell or die’ business practices.

Many professionals appear to have forgotten, or simply didn’t know, that these events happen somewhere in the world as regularly as a really decent British summer – that is, around once in five years. Indeed, they are regular enough to keep some people in almost permanent employment cleaning them up, myself included.

There is one difference this time around. In the good old days of the traditional bank crises, that is, reckless lending to those with no ability, or intention, to ever pay back, the bank suffered the consequences. Now that we have the fabulous invention of a structured market with a cool name to pass on such stupidity to even more foolish investors, it becomes a market crisis instead.

Of course, most of the world’s major hedge fund joined in, but as we all know most hedge funds don’t really know anything about anything. The surprise was that the very large, sophisticated banks with top-quality credit risk management one would have expected never to have written these risks themselves were only too happy to buy such poor-quality risk written by lenders with no standards.

As usual, Wall Street got paid handsomely for the privilege of selling garbage dressed up – tech stocks yesterday, CDOs today. Even worse, nobody ends up knowing quite who actually owns this junk or who the end-risk is. The ratings agencies went along for the ride and the regulators appeared asleep at the wheel.

I see no reason for undue pessimism on the broad economy outside the US. The US has been slowing for at least four quarters. While problems in the housing sector appear to be amplifying this trend and hurting the American consumer, the damage to the US$13 trillion US economy is containable. Corporate balance sheets, profits and debt levels remain in good shape.

Too much is made of the level of export dependency of Asia on the US, and some pain over the next six months will not derail the largest, consumer-based Asian countries – China, India and Indonesia. For the medium term, I maintain my long-held bullish view on both Asia broadly and the Asean economies as well as Asian currencies.

Other than some tech exporters, and employees of the wrong banks, I do not believe you should be unduly worried.

Given my focus on long-term fundamental trends with the background of the sorry tale of US sub-prime, this seems an appropriate time to revisit my favourite worry – the greenback. I have not voluntarily held a US dollar, other than as a short, for over four years. However, consistent dollar bears have often been in the wrong, particularly versus the yen. From March 2002, the yen did strengthen through to March 2005 with the recovery in the Japanese economy, but then turned negative again. Within a year the US dollar was back to 120 yen and has range-traded ever since until recent events. The yen remains the most undervalued major currency. The euro has followed the script better, although again from March 2005 it gave back some of its gains and only reverted to strength against the dollar from May last year.

The core of the bear argument has always been an economic fundamentalist view that goes like this: US debt levels are unsustainably high and continue to grow at an alarming rate; this debt has to be externally financed demanding high relative yields, US interest rates and the level of the dollar are supported by dollar demand via external financing, principally by Asian nations retaining dollars in trade and purchasing dollar debt; and that in doing so, these nations maintain lower yields and weaker currencies than their economic fundamentals would otherwise suggest.

A decade ago Asian nations held one third of global reserves. Now they hold two thirds, mostly in dollars.

The core of the argument for the dollar bears, such as myself, has always been that such a cosy arrangement eventually would have to slow and revert to norm, and that with the purchase of dollars on this magnitude even a slowdown of buying would depress the currency in the process.

For dollar bulls, their argument has been that if Asian and other nations continue to believe in the perpetual cycle of US economic strength and dollar dominance, the attractiveness of US assets, and the exporting advantages of maintaining relatively weaker currencies; then there is no reason at all why the party should ever end.

Asia will continue to export to the US consumer, and simply recycle the dollars back by building dollar reserves and buying US debt.

For a long while it seemed as if dollar bulls were right and a sort of perpetual motion had been built up with the understanding of all parties that this was the game. Capital saving countries, read Asia, have continued until recently to buy and hold US dollars at an unprecedented rate. But all parties eventually come to an end.

I believe that we may be finally seeing the beginning of the end of a long-awaited, slow decline of an aged warhorse, just as the sterling gracefully declined a generation ago.

Of course, the dollar has some uses, which I am sure will continue. I do admit that a wad of dollars has no equivalent for bellboys, and visas-on-arrival in Asian airports. For buying oil, and weapons, dollar remains the currency of choice, as I hear it is for the drug trade and other interesting segments of the cash economy. But even that may change over time.

If the greenback remains on my short list, what then is our currency of choice? Of course, if you are a speculator, going long, the Asian units undervalued on a purchasing power parity basis makes sense – particularly the yen, the ringgit, and the won.

But as economic fundamentalists we do not believe in currency speculation, despite the modern trend to call it an asset class. What an investor in real assets needs is a currency that provides all of the upside potential of the Asian economic growth story, with stability and smart management against extreme volatility.

The ideal would be a balanced currency basket of a weighted proportion of the best of those currencies, continually managed and adjusted relative to macro economic movements. There is such a basket. Even better, it is managed by some very bright folks who charge nothing for the service. It is called the Singapore dollar, and it remains our investment holding currency of choice.

The author is managing director of the Calamander Group and the economic spokesman of the British Chamber of Commerce in Singapore.


Source: Business Times 1 Nov 07

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