A Russian Take on the Rise of the U.S. Dollar
t’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 share 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 economy’s 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 (NYSE: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. The Russian Stock Exchange has also outlawed short-selling. And the Russian government has authorized the purchase of $20 billion worth of shares.
Just yesterday, Russian President Dmitry Medvdev 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, which have 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 the 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 too 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 (NYSE:UUP) over the past two weeks is any indication, the almighty dollar is still the most trusted currency in the world.
Good investing,
Andrew Mickey
Chief Investment Strategist, Q1 Publishing
