The Rise of Dollar Vigilantes

MaxOut Savings Show Report

With Ted Geoca & KNTH 1070AM

MaxOut Savings Advisors, LLC

11/30/2006

SAVE AGGRESSIVELY AND INVEST CONSERVATIVELY!!!

Rise of the Dollar Vigilantes

Over the last 25 years so called bond vigilantes influenced fiscal and Federal Reserve policy in the United States, there has now been a shift to the "Dollar Vigilantes."

In the 1980s and 90s the financial world was policed by the "bond vigilantes" that would threaten when the US government fiscal policies got out of line or the Federal Reserve monetary policy was viewed as easy. The implied threat would be that if investors became concerned about inflation they would react by selling Treasury bonds. Over the last decade this has fallen by the wayside as foreign governments became the larger buyers of US government debt. They would buy regardless of what happened as they had to recycle and invest their trade surpluses in US dollars. As these foreign reserve holdings have approached $1 trillion for some countries, concern has arisen about the need to diversify away from the dollar. China's foreign reserves are now thought to have exceeded $1 trillion. China's Central Bank Governor Zhou Xiaochuan among others has spoken of China's intention to diversify its dollar holdings. This sentiment has been echoed by central bankers around the world. Counties around the world are now less inclined to hold dollars. This has eliminated a natural support for the dollar that has existed over the last 4-5 years. The following chart (Fig. A from the European Central Bank), the explosion of foreign exchange reserves that has developed in many countries around the world. These countries are now paying much closer attention to what happens with the US dollar as their holding have gotten to be so large. The foreign exchange numbers for the counties listed in the chart below will be materially higher across the board for 2006.

This is leading to the rise of the "dollar vigilantes." In addition to countries with large dollar holdings in foreign exchange reserves, hedge funds with almost $2 trillion would be included in this group. This $2 trillion can be magnified many times by leverage. Hedge funds are naturally mercenary in their investment choices and are a potential destabilizing force on the dollar. Remember what happened when George Soros cracked the British pound in 1992? In 1992 George Soros a major hedge fund manager forced a devaluation of the British pound by shorting close to $1 billion of British pounds. At the time it was widely assumed that the pound was too large to be attacked. Consider that hedge funds are now overall a hundred times bigger in today's financial markets. This could force the US to reign in deficit spending in the future. This will also make it more difficult for the Federal Reserve to reliquify if the economy slows down in 2007 as we expect. Starting in 2001 the Federal Reserve took Fed Funds down to a low of 1% due to concern about an economic slowdown and deflation. They do not have the ability to repeat the decline to 1% if we enter a recession because the dollar could begin to freefall as dollar holders around the world assert their concern about debasing the dollar.

Recessions and the Fed
As can be noted on the chart below (Fig. B), as the economy slows the Federal Reserve tends to cut the Fed Funds rate to cushion the declines. With the concern about dollar vigilantes the Federal Reserve will have less flexibility in cutting the Fed Funds. It will be very difficult to cut rates again to 1%. If the Fed's rate were to be cut to 1% the dollar could fall precipitously. This could be result in the Fed lagging the markets on interest rate moves more so than they have in the past as they keep one eye on the economy and the other on the dollar. This is similar to what happen in the last 25 years as investors watched the long bond as a gage on the economy and the Fed.

Much Lower Interest Rates?
At MaxOut Savings Advisors we believe that these changes will manifest themselves in a number of ways. This will force the Federal Reserve to be much more vigilant on inflation. This can be seen in the remarks made recently by a number of Federal Reserve Governors concerning inflation and the need to stay vigilant. They are being very clear that they will keep up rates and fight inflation. We believe the dollar is the main reason they are making this case. We expect interest rates to stay higher than anticipated as the economy weakens to support the dollar. This is why we see the dollar drop when the economic numbers show the economy weakening. This will translate into less help for the housing market than is expected and more concern for financially leveraged companies as the economy slows. This should lead to a longer term economic slowdown and a slower recovery. Over time the recovery could benefit more from a declining Dollar and less from interest rates than past recoveries. Given the present situation with the dollar vigilantes, it is important to recognize we have less room to maneuver in fiscal and monetary policy than we have had in the past.

MaxOut Savings Advisors is an SEC registered investment advisor. As fee only based advisors we charge an annual fee to manage your portfolio investing in stocks, bonds and no-load mutual funds. We use Fidelity Investments to handle the custodial and brokerage services for our clients. If you would like MaxOut Savings Advisors to manage your IRA Rollover or Trust we would be happy to sit down and meet with you. If you would like to meet with us or have a question please give us a call at 713-627-0400 or email me at ted@maxoutsavings.com.

Remember to Save Aggressively and Invest Conservatively!

Did you know that the MaxOut Savings Advisors money managers can now manage your IRA Rollover at Fidelity Investments? At MaxOut Savings Advisors we use Fidelity Investments to handle our investments for our clients. We invest in stocks, bonds and Fidelity and non-Fidelity no-load mutual funds. If you would like to sit down with us at MaxOut Savings Advisors and discuss your IRA Rollover or 401-k or just a retirement review give us a call at 713-627-0400 or email me at ted@maxoutsavings.com

Ted K Geoca

President

MaxOut Savings Advisors, LLC

Houston, Texas

ted@maxoutsavings.com 713-627-0400

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The MaxOut Savings Show and Report does not give out financial advice. Any recommendation or idea may not be suitable for all investors. Moreover, although information contained herein is believed to be reliable, its accuracy cannot be guaranteed. MaxOut Savings Advisors, LLC may or may not have positions mentioned herein. MaxOut Savings Advisors, LLC is a Registered Investment Advisor with the SEC. You should always make investment decisions based on your own financial situation.

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