“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 to sell US bonds 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.  Countries 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.”

Falling Dollar
Fast forward 10 months where the US Dollar has now fallen dramatically as can be seen from the dollar vs. other currencies chart listed below.  It is now threatening to free fall.  We believe that a falling dollar will continue to be an ongoing story.  On October 18, the IMF International Monetary Fund took the unusual step of stating that the dollar is poised for further fall.  At the same time Eisuke Sakakibara, Japan’s former top currency official stated, “Should US growth fall below 1% we could see a plunge in the dollar”.  Therefore the question becomes, if the dollar falls much further how will we support the dollar?  If we cannot support the dollar through foreign exchange buying then we will have to use interest rates.

Very Low US Foreign Exchange Reserves
This concern about the dollar is leading to the rise of “dollar vigilantes”; hedge funds or countries that could force the Federal Reserve to raise interest rates to defend the dollar from falling too far.  If the dollar were to fall too quickly the Federal Reserve could be forced to actually raise interest rates in an environment where the economy is actually slowing.  There are several ways to support the dollar, one way is for the Fed to raise short term interest rates or conversely have other countries cut their respective short term rates in their country.  This was done in the 1970s from time to time to defend the dollar.  Another way is for a Central Bank to purchase the dollar with their foreign exchange reserves.   Looking at the chart below, the Federal Reserve does not have the capacity to defend the dollar against other currencies.  The foreign exchange reserves are foreign currency deposits held by a country’s Central Bank or monetary authorities. As can be seen from the table, our US foreign exchange reserves have fallen behind 18 other countries.   As can be seen China and Japan have the largest amount of money.  Therefore we believe the Fed will support the dollar by a combination of other countries buying dollars and the Fed raising interest rates.  The result of all this is that the Fed will have less room to lower interest rates than they have in the past.

The following chart lists the foreign exchange reserves (currency reserves of each country’s Central Bank) of each country.

Rank Country/Monetary Authority Foreign exchange reserves (millions of USD) Date of info

World (sum of all countries)        $6,235,085 Jul 2007

1.  People's Republic of China      $1,585,500 Sep 2007

(includes Hong Kong and Macau who have

different currencies)

2.  Mainland China                  $1,433,600 Sep 2007

(does not include Hong Kong and Macau

central bank holdings)

3.  Japan                           $  945,600 Sep 2007

4.  Eurozone (EU meml. ECB)         $  439,342 Jun 2007

5.  Russia                          $  434,000 Oct 2007

6.  Republic of China (Taiwan)      $  262,940 Sep 2007

7.  South Korea                     $  257,290 Aug 2007

8.  India                           $  247,700 Sep 2007

9.  Brazil                          $  161,552 Sep 2007

10. Singapore                       $  152,449 Sep 2007

11. Hong Kong                       $  140,800 Sep 2007

12. Germany                         $  116,681 Jul 2007

13. France                          $  102,992 Jul 2007

14. Malaysia                        $   96,800 Aug 2007

15. Algeria                         $   90,000 Sep 2007

16. United Kingdom                  $   85,217 Jul 2007

17. Italy                           $   81,883 Jul 2007

18. Thailand                        $   78,200 Sep 2007

19. Mexico                          $   77,934 Jun 2007

20. Turkey                          $   70,657 Jun 2007

21. Australia                       $   67,084 Jun 2007

22. United States                   $   65,855 Jun 2007

23. Libya                           $   65,419 Apr 2007

24. Switzerland                     $   65,242 Jun 2007

25. Iran                            $   65,000 Jun 2007

26. Norway                          $   56,626 Jun 2007

27. European Central Bank           $   54,710 Jun 2007

(ECB, reserves not wholly owned

by any single EU member)

As the US dollar declines it should be very bullish for US companies producing products that are made here and used overseas.   Many large US multinational companies fit the bill for this as people around the world buy US products that are now cheaper due to the decline in the dollar.  This decline in the dollar will make US products more competitive worldwide.

Sovereign Wealth Fund Bull Market

In 1854 the Texas legislature created the Permanent School Fund (PSF) by setting aside a $2,000,000 appropriation to benefit the public schools to Texas.  Then in 1876 the Constitution was written to place a large amount of land in west Texas in to the PSF.  Oil was found on that land and the money was used to build up Texas A&M and the University of Texas into the great schools they are today.  As well as help build up our public school system in the state backed by Texas school district bonds.  After all that the PSF still has over $7 billion in investments.    Now, many countries around the world are trying to imitate Texas’ success in their own countries.  

Libya today announced they are starting a sovereign wealth fund with $40 billion that had been managed by Central Bank that will now be managed by the new entity the Libyan Investment Authority.  They will invest in stocks, bonds, commodities and real estate.  The Libyans are merely following in the footsteps of the Chinese, Russians and Arab States and countries around the world as they seek to diversify out of US dollar denominated foreign exchange holdings and diversify into other assets for the long term good of their country.  As can be seen from the foreign exchange chart above there is a lot of money available. There are already over $2 trillion in these types of funds and the number is growing every day.  We believe this could be a very bullish development over the long term for large cap multination companies as these funds around the world seek to diversify into high quality US companies.

Outlook

As we have written about we are in a period of slow growth in the US economy as the debt bubble of the last 10 years is unwound. Given the huge run up in debt levels in real estate, hedge funds and investment banks we are expecting continued problems to come out and would continue to avoid financial sector stocks and bonds.  There are still a number of hedge funds and SIVs in financial trouble whose problems are just now coming out.  Therefore we are maintaining our cautious stance and have said one should use this run up in the stock market to reduce risk.  It will take time for this massive debt bubble to unwind.

For now we believe the dollar poised to fall against the Asian currencies more so than the European currencies.  We expect that for the reasons detailed above we could see big moves up in the precious metals markets as part of this foreign exchange money will move into gold and silver asset classes.  The bull markets in gold and silver should continue for several more years.   We are still somewhat cautious on China and the less developed markets as their markets seem to be ahead of themselves overall.  For 2007 we have stated that quality would be king and that remains so today.  On the fixed income side we would overweight money markets and short term high quality bonds.

Overseas Qualified Plans

On the MaxOut Savings Show we get a lot of questions on qualified retirement plans in other countries.   We are often asked if we can manage those accounts at MaxOut Savings Advisors.  The problem comes in that you cannot rollover a qualified plan from another country into an IRA rollover or qualified plan according to the present IRS regulations.  Therefore, the money generally needs to stay in the country you worked in.  The one way to move the money and have it invested in the United States is to pull the funds out of the overseas plan, pay the taxes and possible penalties, then move the funds into the United States.  This is generally not the best way to go as your account will be reduced by the amount of taxes.