Flight to safety in 09, USD, Gold, Euro, Yen

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Why the USD rallied in 08

In 08, it's clear the USD rallied for its own reasons – flight to cash, the USD being the major settlement currency by far, and also deleveraging in everything, and thus the USD rallied to most currencies in second half 08. But Gold spot held up very well compared to the general commodity complex or energy complex, both of which are very tied to world economic activity. As we mentioned in previous articles, gold tracked major events in the Credit Crisis that started in Oct 07, spiking when there were new bad developments, and relieving when there were improvements. So, flight to safety benefitted the USD, gold, and US Treasuries (and German Bunds too).

Interesting caveat on the US T bubble breaking

It's said there is a US Treasury bond bubble, but there is an interesting caveat here. First, there is indeed a UST bubble. But the question is, what is driving it, and can it be sustained? I would like to point out there is also, and has been, a Japanese bond bubble since their deflation, and how many years has that lasted with yields at virtually zero?????

I consider the Yen and the Dollar sister currencies in many respects. Well before China emerged as a big story, Japan and the Fed both have closely coordinated policy to support the USD at times, particularly in crises. Now, at the moment, the Yen is strengthening for its own reasons, mainly deleveraging of the carry trade that built up for ten years. But Japan and the Fed support the USD closely. The caveat on the US T bubble breaking is can the US Ts hold their bubble similar to Japan's bond bubble?

USD still a haven?

In any case, the question now arises if the USD can stay the safe haven of choice with all the new borrowing ahead. One thing to point out is that Japan has had this bond bubble practically forever, and gotten away with it. Can the US pull off the same trick, or at least, get away with its own bond bubble for longer than expected?

There is a big difference though between the US and Japan, in that the US savings rate was/is practically zero, where Japan had a very high domestic savings rate. So, that fact alone could indicate that the US bond bubble might not be as sustainable as Japan's. However, the comparison is still intriguing.

Gold still a haven?

Getting back to gold, it has clearly shown since Oct 07 that it remains a safe haven. Gold spot has resisted the general commodity and energy selloff in 08 fairly well. The USD also has clearly remained stronger as markets deleverage, and so have US Treasury bonds. The Yen has risen a great deal in recent months, much to the angst of Japanese exporters who are calling for intervention. The trouble is, there is so much Yen carry out there, that for the BOJ to try to stop that is like standing in the way of a tidal wave of unwinding, if markets everywhere want to unwind, which they are.

And then there is the general issue of the danger the USD is in, because of our fiscal deficits which are exploding. But the other nations too have this problem, as they fight deleveraging in their markets too, with $trillions worth of their own money. So, what might be called competitive devaluation or monetization in all major currencies is underway as well in 09, and that means the USD can still stay stronger than it might.

I guess the conclusion here is to expect that gold, the USD, and US treasuries can remain safe havens in 09, but I do think the US T bond market can pop, if there is a spike in US interest rates (if people tire of buying $trillions of new US T bonds/notes).

And finally, the Euro has some serious issues, for one thing the ECB is also flooding $trillions worth of Euros out fighting their own credit/banking crisis, and the EU is also diving into recession. One would think the Euro would have a chance to rebound, particularly since it dropped so much in 08, and since their central bank is much more restrained on interest rate cuts. But, a rapidly deteriorating EU economy might cancel that out, and the Euro still keep falling.

Anyway, we have these discussions on an ongoing basis in our PrudentSquirrel newsletter, which is published weekly, with mid week email alerts. We invite you to stop by and check us out. We have made a lot of great calls in 08, such as notice the USD appeared ready to rally, in April of 08, and that a subsequent general commodity sell off was ready. Also, that gold may be bottoming several months ago, around early November. And many other calls through the year.

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