From Chris Mayer, Analyst, Bonner & Partners:
Almost no one understands how the modern fiat-based money system works. That’s why I recently sat down with uber-successful money manager Warren Mosler.
Mosler retired to St. Croix in the U.S. Virgin Islands over a decade ago. But from 1978 through 1997, his Illinois Income Investors fund was one of the top ranked in the world. Mosler’s secret? Exploiting other investors’ misunderstanding of the fiat money system.
In a recent edition of Bill Bonner’s Diary, we got Mosler’s take on what ultra-low interest rates mean for the global economy (You’ll find his comments in the “Portfolio Insight” at the bottom).
Now, we’ll talk about one of the trading ideas he likes best in this environment…
As we discussed in the Diary, Mosler believes that the world economy is on the edge of a deflationary recession. And central bankers’ zero-interest-rate policies (ZIRP)… and now negative-interest-rate policies (NIRP)… are making it worse.
Mosler’s advice: Bet on a stronger euro against the dollar.
Most people think the European Central Bank (ECB) will continue to drive rates lower. And that these actions will weaken currencies and spur inflation.
But this is a myth…
Governments are net payers of interest. If you hold a government bond, the interest payments are part of your income. When a central bank lowers rates, they lower that income. That’s deflation… not inflation.
Lower rates mean less money floating around. It strengthens currencies. And that’s what we’ve seen with the U.S. dollar.
And there’s another reason to expect a stronger euro…
The European Union (EU) has a large and growing trade surplus. When EU exporters ship goods, they’re paid in a foreign currency. But that currency has to be converted back to euros to pay their workers. This drives the demand for euros higher.
Mosler pointed out that for two decades, Japan ran large and persistent trade surpluses (and had zero interest rates). During that time, the yen was among the strongest currencies in the world.
In sum, lower income due to falling interest rates, coupled with rising exports, makes the euro harder to get… and more valuable.
So why has the euro fallen so much over the last two years?
Because almost everyone thinks that lower rates will weaken the euro. So they’re selling euros. It’s a self-fulfilling prophecy.
Mosler had a memorable analogy:
If a corn crop failed because of a drought, you’d expect the price to go up because of supply and demand. But say a big company had a huge warehouse full of corn and believed the drought was going to cause prices to go down instead of up. If they started selling their warehouse full of corn, the price would go down even though there was a drought and a shortage. That’s because all of the supply is coming out of the warehouse. That’s portfolio selling, so to speak. Eventually, they’re going to run out [of euros]…
Now, you may recall the ECB’s recent expansion of its “stimulus” plan. It cut rates even further. The euro initially dropped 1% amid renewed portfolio selling… but then staged a dramatic turnaround, climbing 1.8% against the dollar.
Today, it’s actually higher than when the ECB made its announcement.
This rally after the ECB’s latest move may be the clue that the portfolio selling is over and the turn is at hand…
Sincerely,
Chris Mayer
P.S. Tapping the world’s most successful investors for unique ideas has helped me deliver an average return of 28.8% on my recommendations over the course of a decade… and beat the S&P 500 three-to-one. Right now, I am creating a new investment advisory that builds on my proven strategy.
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