Biggest threat to U.S. is growth: Merk

Axel Merk is convinced the U.S. dollar is headed for a fall. As the founder of Palo Alto, Calif.-based Merk Funds, the largest mutual fund company focusing exclusively on currencies, he has been predicting currency market volatility for decades.

In a speech at the CFA Institute’s annual conference in Singapore in May, Merk offered a macro view on the currency world and told observers how to profit from managing dollar risk.

“Where there’s crisis there may be opportunity,” he says.

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The U.S. dollar, Merk contends, is a natural valve to allow the U.S. economy to adapt to global market dynamics. And “free market forces and the unintended consequences of monetary and fiscal policies may push the U.S. dollar lower over the long-term.”

He points to the fact that, despite a lot of political rhetoric, we have yet to see tangible evidence of fiscal restraint by either American political party.

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By contrast, governments around the world – particularly in the Eurozone – have enacted stringent austerity measures.

What’s more, while some see a bright spot in rising consumer confidence south of the border, Merk sees a looming problem.

“The biggest threat that we see in the U.S. right now is economic growth,” he explains. “If you have economic growth, you may see a sell-off in the bond market.”

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Government debt is currently financed at about 2%, Merk points out, down from about 6% in 2001. “What goes down could go up,” he says, “even if it takes a few years. Economic growth may force the feds to refinance that debt at 4% instead of 2%.” That could make the federal deficit unsustainable.

By contrast, Merk sees reason to be cautiously optimistic about the Euro. “The European central bank balancing sheet is shrinking,” he points out. “What you see in Europe is that liquidity is being mopped up.”

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In addition, the Europeans are more inclined to let their banks go bust and let the periphery suffer so structural reform occurs. The upshot: the currency reflects fundamentals more accurately, and that bodes well for its long-term performance.

Merk ended with a pitch for the contribution currencies can make to portfolios. Among other things, they offer the benefits of diversification since they have a low correlation with many asset classes, including real estate, commodities and equities, he says.

And baskets of currencies are inherently more diversified than single currencies and have historically been less volatile than equities or bonds.

Finally, Merk adds active management of currency baskets can enhance returns and cut down on volatility, especially given the current market dynamics.