Is gold a hedge against inflation? Independent Financial Advice

What is the fair value of the U.S. dollar and how will it react to inflation?

The dollar could retouch its highs of 89 on the DXY index. The Eurozone continues unsuccessfully to seek painless solutions to its problems instead of real reforms. The Euro currency will eventually break apart and the Eurozone members will revert to their old currencies. The Yen is risky because the Japanese government’s debt is huge and growing and it has no solution to fix its financial crisis. By default the U.S. dollar is the cleanest shirt in the dirty clothes hamper. Our growing ability to avoid importing oil, gas and coal means that we will send less funds offshore which will help the balance of payments, thus making the dollar do better than the other major nations that need to import hydrocarbons. The very small sized developed countries with strong finances are too small for the world’s gigantic institutional investors to use as a safe haven currency, so as the financial health of japan and the Eurozone continues to decline investors will have no choice to flee to the dollar. This will push up Treasury bond prices and other investment grade bonds, making yields go lower.

Dollar Crash if China Sells Treasuries? Independent Financial Advice

China is selling its dollars and investing elsewhere. Will the dollar collapse?

The Chinese government has reduced its holding of dollars from 75% of reserves in 2006 to 65% in 2010 and it is now at 54% as of June, 2011, according to the Wall Street Journal .

It may be tempting to think that China will sell off all of its dollars and this will cause U.S. interest rates to rise. But as I have said before, the U.S. is the only deep, liquid, reliable market big enough to accommodate Chinas $3 trillion reserves. The only possible exception to that is the Yen or Euro which has lost credibility and become very risky with a significant probability of a breakup. Japans economy is reaching a dangerous stage of ever increasing government debt and permanent stagnation so it would be risky to invest in Yen. Buying gold bullion or Swiss Francs is not possible because those markets are too small for China to invest in without disrupting the market. The Chinese government wont buy U.S. stocks to diversify because Central Banks have a tradition of only owning foreign currency and precious metals, and there is the risk that a stock crash could occur. The dollar, in the form of U.S. Treasuries, is the only game in town, for gigantic investors like China. It is in Chinas best interest to put its holdings into the dollar (in Treasuries) while camouflaging its intention by pretending to diversify elsewhere.

The big picture is that Chinas economy is very similar to the U.S. during the real estate and mortgage bubble of 1997-2007 and eventually it will end in a similar manner. When it does then China will sell foreign currency reserves to raise funds to rebuild the economy. This could hurt the dollar but a way for the U.S. Federal Reserve to reduce this problem would be for the Fed to give China a margin loan against Chinas US. Treasury holdings and thus the Treasuries would not have to be sold. During a world recession the dollar usually goes up in value because it is a safe haven. Assuming we will soon go into a world recession because of the 2013 tax increases and because of Chinas problems then the dollar will go up and the worlds Central Banks will send their reserve funds into the dollar.