The US Dollar is Cheap – but it Could Get Cheaper

John Stepek, MoneyWeek's editor, has been asking me to give an update on the US dollar for several months now.

And I've consistently replied, "Yes, you're right, John, absolutely" and then gone and written about something else.

It's because every time I look at it, it seems so unbelievably cheap, I can't help arguing that it's due a rally.

And then it falls even further.

And then John emails me again.

So in today's Money Morning – unprompted by John – I look at the once mighty US dollar.

Why Canadians are laughing at Americans

The relationship between Canada and the US is not one that I – an outsider – can pretend to understand. But one thing I have noticed is that a lot of younger Canadians, when abroad, like to stress as early as possible after meeting someone that they're not American. (I see something similar happen when Scots are falsely 'accused' of being English.)

On the other hand, I have observed a rather dismissive attitude from many Americans towards their Canadian neighbours. The American comedian Dave Fulton used to joke: "Canada … oh. Well, we could take it if we wanted it".

But with the US dollar in the doldrums, that dismissive American attitude is no longer appropriate. Canada has suddenly become a very expensive country. And in March, while I was at a mining conference in Toronto, I saw that dismissive attitude reversed.

Canadians were laughing at how cheap America is. In the UK we may not notice this as much, because the pound has been relatively weak. But to Canadians, whose dollar has been strong, thanks to its association with commodities and the country's comparatively low debt levels, the US is bargain central.

"I just bought a holiday home. Three thousand square feet. Beautiful garden. Swimming pool. Overlooking a golf course. Free membership. A such'n'such kitchen. A so'n'so bathroom. Just a 90-minute flight from Vancouver", laughed one.

"How much?" I asked.

"180 grand!" he guffawed.

When you consider that Canadian real estate has, broadly speaking, come through the last five years largely unscathed (so holiday homes are not cheap); that his 180-grand house would probably have cost in excess of half a million in 2006; then add another 20% onto that because of changes in the currency; you can see why he's so amused.

The US dollar is incredibly cheap in historic terms

But for how much longer will Canadians be laughing? Here we see a 20-year chart of the Canadian dollar against the US. You can see the wall it has just hit at 1.05. We are at historical extremes.

And talking of historical extremes, look at the US$ against the Japanese yen. We are at similarly – dangerously – stretched levels.

Next we see the US$ against the euro. The euro has not quite reached the summits of 2008 – the eurozone is not short of problems – but it is still very much at the higher end of the range.

And here we see the dollar against the Swiss franc. We're at record levels.

And finally we see the US$ index, which shows the US against a basket of major foreign currencies. What a horrible, horrible chart.

Policy-makers at the US Treasury and the Federal Reserve Bank should take a long hard look at those charts and then at themselves. Is this what they intend?

But what will turn the dollar around?

I look at the above charts – ignoring the fundamentals – and think: "The US dollar has to rally".

I look at the yen and think that at some stage shorting the yen against the dollar is going to be one of the forex opportunities of the year.

I look at the US$ index and think it may be making a multi-year 'double bottom', the kind of low that gold made in 1999 and 2001.

But something has to happen to trigger a reversal.

I see no evidence of a change in policy that is likely to reverse things. I see no rise in interest rates. I see no real fiscal responsibility – there are noises but little more than that.

I see no reining in of spending, no paying down debt, no cutbacks, no steps towards greater efficiency. I see plenty of signs among the American people, but none in its government. And, ultimately, the US dollar is the issuance of government.

Perhaps some kind of crisis will force those policies onto government, I don't know. Markets are looking decidedly dodgy at present (though that is consistent with the time of year). Perhaps we are at the cusp of phase two of the Global Financial Crisis. Perhaps that is what has rallied the dollar over the past few weeks and that is what will continue to rally it.

But for now, all we have seen is a pullback to the 50-day moving average, a normal technical retracement in an on-going trend. If the slide resumes, and the dollar falls below its lows of 2008, the Federal Reserve and the US Treasury risk letting the inflation they have created run out of control.

And if it slides below those 2008 lows, other governments will get reckless in an effort to devalue their currencies.

Put it this way: I'm glad I own gold.

This article first appeared in Money Morning, the free daily investment email from UK investment magazine, Moneyweek. Sign up here - it's free.