Prices of most natural resources will go up…a lot. That’s why lots of bears on the U.S. dollar suggest buying gold. We are sympathetic to this idea, but we’d suggest a slightly different strategy: Sell bonds. Buy energy.

When a large holder of U.S. dollars declares that the dollar is in “great shape,” should we believe him? My answer is, “Probably not.”

Russia’s Finance Minister Alexei Kudrin told journalists this week that the U.S. dollar is in “good shape.” He added that, “It’s too early to speak of an alternative [to the U.S. dollar].” These remarks came after Chinese and Russian officials have quite publicly suggested that the world’s financial system would benefit from using a currency that wasn’t being run by a bunch of inflationistas in America.

But the dilemma for the large dollar-holders of the world – Japan, Russia, and China to name a few – is how candidly they should verbalize in public about what everyone knows in private. By blowing the whistle on the Fed’s inflationary monetary policy, dollar-holders penalize themselves. The lesson? There’s a price to pay for rightly pointing out that a huge supply of Treasury bonds threatens the credit rating of the U.S. That price is paid by owners of dollar-denominated assets.

The dollar-supportive remarks by Kudrin, then, should be seen for what they are: a white lie, designed to halt the dollar’s slide…at least temporarily. In the meantime, however, you can bet that these same dollar-holders are working behind the scenes to find alternatives to the greenback and, of course, to diversify their currency reserves into other currencies or tangible assets. It’s just that you don’t want to precipitate a crisis until you’re good and ready to profit from it with a well-planned trade. Goldman Sachs would never make that kind of mistake!

There may be a few escape avenues from the dollar. It comes down to figuring out what-if anything-will go up when the U.S. dollar resumes going down. In fact, the question on everyone’s minds is what U.S. creditors will do with their money if they aren’t lending it to Barack Obama to spend.

“Over time,” says Nouriel Roubini, professor of economics at the Stern School of Business at NYU, “the willingness of the U.S. creditors to finance U.S. spending and buy dollar reserves is going to be reduced. People are getting nervous rightly about us devaluing or inflating our way out of the debt problem and causing real losses on the holdings of those assets.”

If you’re losing money on an asset, naturally you’re going to either sell of it, or at the very least, accumulate less of it. But then what? Where does your money go after that? We’d suggest the investment needs of the emerging market nations are the natural replacement for throwing away money in the U.S. Treasury market. Granted, there’s risk in emerging markets. But it’s now clear there’s risk in the sovereign bond market too. Take your pick.

Speaking of those emerging markets, four of them spoke with one voice in Russia this week. The leaders of Brazil, Russia, India, and China gathered to figure out how to solve their dollar dilemma. Criticize it too much, you lose value on your current dollar-denominated holdings. Do nothing, you lose value on your dollar-denominated holdings as Obama and his Congress spend America into poverty and servitude…and then inflate like mad men.

“There is a strong need for a stable, predictable and more diversified international monetary system,” the final statement from the BRIC nations read. Russia’s Dmitry Medvedev added his own “two roubles,” saying that existing reserve currencies, “have not managed to perform their functions.”

And what is the function of a reserve currency? Well, it’s probably the same as the tripartite function of any money: as a store of value, a unit of account, and a medium of exchange. Countries hold baskets of currencies (yen, Euros, Swiss Francs, U.S. dollars) in order to conduct international trade and commerce.

Of course all this is relatively new. That is, when money used to be a commodity (gold and/or silver) then a country’s monetary reserves were the same as its precious metal reserves. Debtor nations that consumed more than they produced and borrowed to do so paid the price in a net outflow of commodity money. But things don’t work that way in a world where everyone uses fiat money. So what we’re seeing now is a worldwide monetary system that is, well, systemically flawed.

Make of it what you will. What we make of it is that the very foundation of the world’s commerce and the currency in which it’s conducted is shifting. The stock markets of the world have no idea what to make of all this because it is not clear yet who the winners and losers will be.

All that we know is that paper currencies and government debts are proliferating very rapidly. We also know that natural resources are not. In fact, they are depleting very steadily.

So we conclude that the prices of most natural resources will go up…a lot. That’s why lots of bears on the U.S. dollar suggest buying gold. We are sympathetic to this idea, but we’d suggest a slightly different strategy: Sell bonds. Buy energy.

Source: Sell Bonds, Buy Energy

Editors Note: Pulbished by the Rude Awakening, this article origianlly appeared in the Australian Daily Reckoning

Last 5 posts by Dan Denning

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• China Performs a Kind of Financial Alchemy - May 19th, 2009
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