Why the Dollar May Not Be Safe

What is the most crowded trade in the world? Why, the U.S. dollar of course. And it’s becoming more crowded by the day. Here’s the Merrill, Lynch take:

So, what do you think? Can the most crowded trade be the right place for your money?

The argument for a stronger dollar is that Trump’s economic policies will strengthen the U.S. economy. First, it is widely believed that a border tax on imported goods, which Trump has said he favors, would cause the U.S. dollar to strengthen anywhere from 20 to 25%.

Second, part of the tax plan is to allow US multinationals to repatriate the roughly $2 trillion they have offshore. If this money is being held in other currencies (which I doubt), bringing it back home would create added demand for the U.S. dollar.

Third, in the early 1980s, when President Reagan cut tax rates and boosted fiscal deficits, the U.S. dollar became very strong and many observers are looking at that to repeat itself. The world is much different now than it was in the early 1980s. At that time, we had the highest interest rates in the history of capitalism. Now we have the lowest interest rates in 5,000 years. Also, debt levels are much higher now.

Here is the other side of the argument. The key question is whether the Trump administration wants a weaker dollar to boost U.S. exports. Given the fact that on a purchasing parity basis, the dollar is extremely overvalued versus the euro, the yen and the British pound, it seems to me that the best strategy for the President is to talk the dollar down. In the WSJ interview with Donald Trump, the president-elect said the dollar was already “too strong” and blamed this is in part on China holding down its currency. He added that “our companies can’t compete with them now because our currency is too strong. And it’s killing us.” The dollar promptly began to fall.

While Paul Ryan’s plan of a border tax might sound good to academics and theorists, I wonder whether it will be enacted. Retailers are opposed and they have their allies. Some Senate Republicans have expressed skepticism about the wisdom of a border tax, raising doubt about its ultimate passage. Imposing an import tax would clearly bring retaliation against U.S. exports, so exporters may not be as supportive of the tax as many expect.

Also, I do not believe the Fed will raise interest rates three more times in 2017 as they have claimed. The economy is not strong enough as the data shows. First quarter GDP estimates are once again being marked down. The key numbers for the Fed are the unemployment rate and wages. If unemployment keeps rising–recall that it has actually risen from 4.6% in November to 4.7% in December to 4.8% in January–then the Fed may find itself cutting interest rates before the year is over.

Everyone is bearish on the euro which is threatened by upcoming French and German elections. Marine Le Pen as President of France would be disastrous for the European Union and euro. When it comes to politics, it is very hard to make investment decisions because electorates are very volatile. However, I am beginning to think that the universal bearishness on the euro may already have priced in the worst case. The Brexit vote, the Trump election and the Italian referendum are recent proof that the market over-reacts before the news and then quickly heads the other way.

My conclusion? I hold dollars but I’m nervous. Dollars are a safer bet than the stock market but probably not as safe as gold.