The Fiscal Cliff’s Biggest Surprise Could Be a Rising U.S. Dollar.

My grandmother Mimi had a saying that was as blunt as it was uncouth. “When the stuff hits the fan,” she used to say, “it will not be evenly distributed.”

This one came up often when she sensed that world events were about to take a turn for the worse. 

You’ve heard me mention Mimi before. She was widowed at a young age and went on to become a savvy global investor long before people thought to look beyond their own backyard.

Mimi never cared what Wall Street’s “Armani Army” had to say. 

Instead, she preferred to travel widely to see for herself what the real story was. Having grown up in the midst of the Great Depression, she believed that people were the ultimate indicator and that governments were the penultimate contrarian influence.

If she were still alive today, I think she’d encourage us to take a good hard look in the proverbial “mirror” especially with regard to the looming fiscal cliff making headlines the world over. 

And I don’t think she’d waste any time with the doom, gloom and boom crowd either. 

She was always on the hunt for opportunity when everyone else was running from chaos. Thanks to her, it’s a habit that remains firmly ingrained in me today. 

Not One but Three Fiscal Cliffs

And that brings me back to the “fiscal cliff.” 

In my mind, this is a misnomer. There isn’t really a singular fiscal cliff. As I explained earlier this summer to Sheryl Nance of Forbes there are actually three. 

• The massive adjustments headed our way as tax and spending cuts expire and come into effect beginning in 2013. You may know it as taxmegeddon.
• The debt debacle and the near complete lack of any sort of credible financial consolidation plan that will affect everything from interest rates to collateral requirements and the US credit rating – again.
• And politicians who simply don’t understand that issues 1 and 2 are already dramatically impacting the economy long before the theoretical limits of spending come into play. Profits are declining and 61% of companies that have reported through Monday October 22nd have failed to meet expectations. Hiring is slowing and top line revenue is increasingly hard to come by.

Together, they constitute a massive threat to the U.S. economy that could push our beleaguered “recovery” to the breaking point. (And I use all the sarcasm I can muster with that because our recovery isn’t anything close to what’s needed.) 

Many believe this is a moot point because Congress will get down to business in November after the Presidential Election takes place. The hope is that some sort of budget agreement will be reached and that the US economy will then be positioned for stronger growth in 2013.

Yeah and I suppose the tooth fairy will show up, too. 

The IMF and CBO are both on record noting that the estimated $400 – $600 billion in impacts that will result from the combination of spending cuts and tax hikes could derail economic growth while causing a sharp contraction. 

Even Helicopter Ben himself has warned of dire consequences. More importantly, dozens of reformed economists, bankers, CEOs and small business owners agree. 

Any breakdown in the political infrastructure would represent a catastrophic political, social and economic failure that places literally every level of our economy at risk of further disaster. 

Under these conditons, everything from our credit rating to international trading relationships faces mortal risk. 

Europe could also come unglued if our banking system goes south. I know many European leaders like to believe they are independent but the reality of an internationally linked fractional banking system renders that notion pure folly in this instance. 

Is There a U.S. Dollar Rally Brewing? 

Conventional wisdom, under the circumstances, is that the U.S. dollar will become even more worthless than it is now. 

I don’t think so. In fact, I expect the U.S. dollar to strengthen significantly. Here’s why… 

When the shooting started in the Middle East, bankers came running. When the fiscal crisis began, the dollar ran some more. When the European crisis broke, people couldn’t get enough dollars.

And as China had slowed, the dollar has enjoyed newfound stability. Even during last year’s Congressional debt ceiling donnybrook for example, the dollar outperformed the Euro as investors sought refuge. 

History shows that bankers from Shanghai to Milan and all points in between run to the dollar when global instability raises its ugly head and the fiscal cliff or cliffs would certainly constitute instability.

And that reminds me of something else Mimi used to allude to all the time. 

“Keith,” she would say as we enjoyed some piping hot pastrami sandwiches and cold beer together (one of her favorites), “much of the world may hate our guts, but when the fur starts flying they love our money.”

These days they have to. For the moment, there’s literally no alternative capable of absorbing the needed liquidity. That alone is probably worth another 10%-15% of upside for the U.S. dollar. 

As for the alternatives, the euro itself is in question and at risk of fracture and the yuan isn’t deep enough yet. 

As the dollar goes higher, US-based stocks, bonds and preferreds should go along for the ride if not in terms of absolute gains, then in terms of stability. Investors factoring in dividends and bond payments, even at historically low interest rates could enjoy their own recovery.

So, too, could the Chinese who sit on an estimated $3.2 trillion in trade reserves and an estimated $1.169 trillion of which is held in U.S. dollar denominated debt.

Many people don’t want to hear that. But understanding how a stronger U.S. dollar would affect the markets may lead to some the most profitable decisions they’ve made since this crisis began. 

Best Regards, 

Keith Fitz-Gerald, Chief Investment Strategist 
Money Map Press

Further Reading…

Mimi’s sage advice has appeared in Keith’s columns before. In this article, she reasoned that when an investment or a trend began making the rounds over drinks, it was time to move on. In fact, she used to call it the “country club” test. Here, Keith talks about why she’d fire Microsoft CEO Steve Ballmer.

Mimi was also mentioned in Keith’s 2009 book entitled: Fiscal Hangover.