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A Russian Perspective on the Rise of the U.S. Dollar

by: Andrew Mickey October 12, 2008 | about stocks: RSX / UUP    

Andrew Mickey

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It’s all falling apart. The world fears the global financial system is on the verge of collapse and a long drawn out recession could be in our future. It’s going to be a long one and the commodity bull has been stopped in its tracks.

Oil, coal, uranium, copper, nickel, and other base metals are steadily declining in price almost every day. It seems like there is almost no let up in the selling at times.

The sell-off has wreaked havoc on the shares of mining companies. All of the majors across the board have dropped anywhere between 50% and 70%. It’s been a tough couple of months for mining companies.

Of course, they expect the volatility. They’re used to the cyclicality of the industry. Mining stocks have been subject to huge swings for decades. The executives, engineers, geologists, and laborers are used to it. Frankly, it’s not about to change anytime soon. Imagine an entire country whose economic success was dependent on high commodity prices? How would it react?

Well…the world has one and it’s not reacting well.

Russia has taken the commodities sell-off on the chin. The Russian ruble has fallen 10% since its highs against the U.S. dollar in July.

The Russian stock market, as tracked by Market Vectors RSX ETF (RSX), has fallen 62% this year. The Russian stock market has been halted twice in the past month in hopes of stopping the sell-off (it didn’t even open on Friday). The Russian Stock Exchange has also outlawed short-selling. And the Russian government has authorized the purchase of $20 billion worth of shares.

Friday, Russian President Dmitry Medvedev rolled out Russia’s banking bailout plan. Russia’s plan involves pumping $36 billion dollars into the local banking system in the form of five year loans. On a comparative basis, this cash infusion is about 3.5% of Russia’s GDP while the U.S. plan is about 5.6% of GDP.

Clearly, Russia’s got some problems. But Russia is no stranger to problems. Just 10 years ago, the country’s financial system collapsed when the government defaulted on its debt. The default sent the Russian economy into a tailspin and was the straw that broke the camel’s back of Long-Term Capital Management.

At the time, the Russian economy was a total wreck. 80% of Russia’s exports were timber, oil, natural gas, and metals and commodities prices were sliding (like they are now). Russia was not prepared.

Hundreds of banks closed and people were lined up at banks for days to try to withdraw some virtually worthless rubles. No one could deny it was a true financial crisis.

It took a decade, but Russia eventually recovered. This time many are not about to make the same mistakes. Much like the Argentineans we met the other day, who experienced their own financial crisis when Argentina’s banking system collapsed completely in 2001, Russians still don’t trust their banks. And they trust the government and ruble even less.

That’s why I couldn’t wait to speak with Grigory. He’s been a Russian stock market analyst for years. I met him on a research trip inside the Arctic Circle last year. What he had to tell me really got me thinking.

With Russia’s market in freefall, he’s a pretty busy guy. But I had his attention for a few minutes because he wanted to get the real scoop on what’s happening here in the United States. As you might imagine, Russia’s media outlets don’t always provide the whole truth.

So I explained it all to him and laid out the possibilities from here, then I turned the table on him and asked, “How’s it going over there? Is there 'blood in the streets?' Time to buy? Are you loading up on gold?”

His answer was a simple no to all of them. He warned it could get much, much worse.

But he did tell me his safe haven: the U.S. dollar. Grigory went to the bank two weeks ago and pulled out $25,000 in U.S. currency. Grigory explained to me that I just don’t understand the importance of the U.S. dollar in the rest of the world. He told me, “You’re too used to it. You grew up making and spending dollars. It’s still the world’s most respected currency.”

I fired back, “But there’s inflation, a recession, a financial crisis…”

He stopped me and said, “You know the U.S. dollar will always buy something. It will be there in 5 or 10 years. It will always be accepted by any merchant as far away as Siberia. It’s the world’s safest currency.”

Then I understood. Most of the rest of the world doesn’t trust their governments or currencies enough yet. Sure, we’ve had a nice boom for the last decade which has worked its way to almost every corner of the planet, but if you’ve ever been through a currency crisis or financial collapse, you just don’t know.

The U.S. dollar is still the reserve currency of the world. The euro had its day in the sun over the past year, but it hasn’t even been around for 10 years. It takes a long time for the world to switch to a new reserve. Whether that is eventually the mighty Chinese yuan, the euro, or gold remains to be seen.

One thing we do know for sure. It took a very long time. It took a couple of wars, and the Great Depression for the U.S. dollar to establish its dominance over the British pound. Now, it could all be changing again, but it’s going to be a long volatile process.

If the 10% rise in the Powershares DB U.S. Dollar Bullish Fund (UUP) over the past two weeks is any indication, the almighty dollar is still the most trusted currency in the world.

Disclosure: I have no position in any of the listed shares mentioned.

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This article has 9 comments:

  •  
    Oct 12 11:15 AM
    The Euro hasn't been around but the German Mark certainly has and it is the Euro Proxy, Grigory doesn't have a clue as to what is going on because he comes to you for information and with you going to him, you must be in the dark as well.

    The big difference this time around is the Foreign Currency reserve situation. This year has proved, without a doubt, the instability of the World's Reserve Currency. The Dollar's gyrations destabilize the other Currencies and the current rise is Bubble like in its rapidity. When it starts to drop, not if but when, there will be a rush to the exits.

    The Fed and Treasury are creating Fiat Money, a massive increase in supply is needed internally but unfortunately a lot of it is going overseas as well. Foreign Debt Reserves are now up almost 25% year to year...thats' half a Trillion and that doesn't include the internal creation.

    Meanwhile, the purchasing power of the nations, who hold dollars or are pegged to the Dollar, is starting to erode rapidly and they are starting to decouple. Both the Monetary base and money supply are accelerating on a massive scale but all that is currently doing is escalating the rate of deflation in the US.

    The very thing we are trying to avoid is taking hold. Internal wealth destruction, first in the Housing Market, now in the Stock market and the importation of devalued goods in the Future. All of this is Deflationary. It is a repeat of what occurred after the Internet Bubble.

    But this time around there are Trillions of dollars more than at that time. When repatriation starts from the rest of the world, to strengthen their own currencies, the dollar will drop to new All Time Lows against all Currencies.

    IMHO
    Reply
  •  
    Oct 12 02:43 PM
    To paultaut's comment: This is not science, it's psychology (which is not really a science despite what psychologists say). When people get scared or just a little worried - they go to the dollar. Grigori is right. Every regular person in the rest of the world (outside US and EU) would trust the dollar more than their government, their bank, their currency or the euro.
    Reply
  •  
    Oct 12 03:47 PM
    Whose money will replace the dollar? There isnt any currency that even comes close to the dollar --the main reason may be our military. The rest of the world is weak and no one trusts any of them.

    Why is the presidency of th US fought for so hard? Even though its the worst job in the world (it destroyed both Clinton and Bush). Its because the US is the only country that has real power and trust..
    Reply
  •  
    Oct 12 05:19 PM
    Countries with sufficient foreign currency reserves - like Russia and China - will weather the currency boom/bust gyrations quite well. However, to pay for our 10 trillion dollar debt (or 50+ trillion if you take the Peter Peterson Institute measure), we'll have to gradually - or by leaps and plunges - devalue our currency. Whether it will be done intentionally or for the lack of other options, is not important. In the long run the currency of a country that relyes on export of IOUs can't remain strong compared to currency of a country that relyes on actual goods bought for cash by foreigners as well as its own citizens. The short-term run up and then plunge of commodities nonwithstanding, Russia is an enviable position currency-wise.

    Grigori is scared in the short term. As most Russian "analists" he's most likely got the brains of a petty speculator who is "street smart" and lives in the now, and only now. Raised in the country that went through several crises of unstable and weak governments, he is not trusting his new strong, rich and all-powerful (autocratic but deliberate) government. His reaction is justified by crises of the past, although not necessarily by the current.

    Besides, what is $25K for a Russian market speculator? If he is rich, it's pocket change, a small safety margin in case the bank closes doors for "back holiday." And if he is not rich, and it is big money for him, why do you listen to a poor schmack?

    Finally, don't forget the nuances that might have been lost in translation, even from his Russian English to your American English. The environment in which you function affects your understanding of information. I often speak to my friends in Russia in perfect Russian but as our actions later show we get very different ideas from the same seemingly clear conversations. The same thing happens between parents and teenagers everywhere all the time. So, perhaps Grigori - as smart as he might be - meant something different than you understood.

    My two cents.
    Reply
  •  
    Oct 12 09:05 PM
    its your money.you want to lose it to the bear so be it.putin is a dictator.you dont believe-invest there.they have defaulted again & again.
    Reply
  •  
    Oct 13 12:46 AM
    They defaulted once since the Wall fell, Putin will retain power so the political stability is there, eventually the American recovery will take place and raw materials will be needed especially if long delayed construction projects are finally implemented in the interim.

    I wouldn't take Russian shares if they were given to me, It would be like spitting into a tornado, who knows how fast it would come back at you.

    I'm talking about currency expansion and the future effect
    of that expansion. Being the Reserve Currency does not prevent it from experiencing high inflationary conditions. The 1970's proved that. History does repeat.

    The 70's had the following: the Vietnam war and its end, The end of a Stock Market Bubble called the Nifty Fifty, a spike in oil which went from $3 to 40 with predictions of $100, a Housing Boom and bust, the inflation associated with all of the above forced the Fed in the form of Paul Volker to raise interest rates until a 12+% increase in unemplyment occurred.

    The difference is that the 2000 series includes 2 other Bubbles and now a Deflationary thrust which will inflate the amount of dollars to an extent where there will no expectation by anyone that they will be able to recoup their investments.

    It "is" all about expectations and perception. Hence the strong dollar but the Fed will overshoot like it always does. The Crisis will end.
    Reply
  •  
    Oct 13 09:56 AM
    Russia, what a basket case. Losing population every year,no export economy besides energy, outside of Moscow and St.Petersburg the infrastructure is just terrible, a government that is a criminal enterprise, an army that can only fight against tiny countries, no rules, no laws. If crude falls to $50, they will be back to 1998. The good news, Putin is worth 40 billion dollars.
    Reply
  •  
    Oct 14 11:04 AM
    Considering all the natural resources that Russia holds it is just a matter of time before their markets go up and the rubble appreciates. The current downturn should help the Russians not to get overly arrogant with their newfound wealth and start another cold war. A cold war would be detrimental to the economic interests of both US, Russia and the rest of the world.
    Reply
  •  
    Nov 15 07:38 PM
    As Ross Perot once stated "how many rich economist do you know"? The dollar is a dead man walking due to a soon to be 11.6 trillion national overseas debt due to about a 6 trillion borrow and spend spree by President Dummy Bush ! Currently the USA has a operational revenue problem budget deficit of about 480 billion dollars it needs to operate the fiscal 2009 year- in otherwords the taxes it will collect next year-income taxes and such will be in shortfall that much. 10 to 11 million jobs lost over the past 8 years of Bushism. The US is also borrowing right at 39 billion dollars every quarter to make up its interest payments of about 281 billion dollars a quarter on loans it has gotten from foreign bankers. True stock markets have taken big losses around the world, currency and stocks are two different things my friends. Putin is nobodies fool and the Russian feds have 489.1 billion dollars in solid gold bars in reserve to back up the Russian Rouble is necessary , along with holding about 580 billion in foreign reserve currencies such as yens, dollars, euros, pounds. Bush sold out the entire silver reserves of the US a couple years back, and the US federal gold reserves reports show the same number of ounces on the 2006 accounting reports as the 2008 does to the exact ounce! Only a halfwit would believe that is correct after looking at the West Point gold reserve account sheets showing what is in custodial status- meaning another country now owns it,lol. Independent bullion sellers in the US have not been able to get any gold or silver to sells in weeks now. If Vladimir Putin monetizes and orders gold Roubles into circulation the US dollar would be toast in 6 months or less and the US Feds know it! Yes the Russian stockmarket make hit bottom along with the Dow Jones and others, but the Russian Rouble is solid as a rock my friends and not about to fall to worthlessness again like before! What you are seeing right now with the rise of the dollar is the result of ongoing deleveraging- countries selling US investments and gettting paid off in US dollars. When that phase is run its course the dollar will go from around 87 to 91 all the way down to about 35 or worse!
    Reply
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