Sunday, August 2, 2015

Dollar About To Soar

Almost more important than the Fed's interest rate is the value of the dollar in comparison to other currencies. For years I thought the dollar would succumb to market forces and predicted its demise. I now concede my failure to grasp the larger picture made me rather shortsighted. The dollar has three key strengths we must not forget. The first is the size and liquidity of its market. The second a lack of good currency options as a place to store value. Finally it is the benchmark by which other currencies are judged. Sound a bit redundant? If so it is because again we come back to the issue of the dollar being the best and safest of dreadful and easy choices we have before us. The status of being deemed the "reserve currency" by which all others are weighed and in someway pegged does not make the dollar infallible or guarantee it will remain strong but the liquidity of such a large market does add a resilience to the American dollar.

The above chart highlights the size of this issue
On November 16th of last year I published an article concerning the dollar's role as the World Reserve Currency and pointed out the designation was both a blessing and a curse. Four major currencies continue to dominate the world stage, they are the pound, the euro, the yen, and the dollar. All the remaining currencies of the world remain small bit players and it would seem the balance mechanism to value currencies is skewed in favor of the world reserve currency, but this also means America carries a special burden. The main reason the world has chosen a "reserve currency" is to have some benchmark to judge currency values and lessen the impulse of countries with massive debts to attempt to address their woes by just printing more money.

The way things are structured the dollar is the linchpin of global fiance and has guaranteed itself a place at the table until dethroned. This means that countries like Japan and China which hold a lot of American bonds and thus dollars will be able to offset some of the pain of a weakening national currency unfortunately, most countries are not in such a position. Making  matters worse countries that are mired in debt often have tied or pegged that debt to the dollar this translates into a lot of economic pain if the dollar grows stronger and many will find themselves under a great deal of pressure just to survive.  This is a major reason markets love stability and stable currencies, it provides an environment that yields the most benefits by reducing overall risk. The strengthening dollar may be sending a signal that the global economy is unstable. The fact is many currencies are under assault because both economies are weak and countries are buried in debt they can never repay at real market interest rates.

A change in currency values may be dramatic and using history as a guide markets often show no mercy when this shift occurs. Here in America when the dollar is weak consumers pay more for imports but are able to sell and export more goods and services as they become more competitive. When the dollar gains strength the cost of foreign imports drop and the American consumer is the winner, but it comes at the cost of jobs and lost competitiveness. This is supposed to be a self correcting system with values determined within the free market system. Unfortunately, in a system gone wild where central banks have created massive amounts of fresh money and corrupted the mechanism through currency swaps and backdoor deals that support one currency over another it is rapidly breaking down.  Much of what we see happening today in world trade and currencies is similar to what brought on the great depression. Currency devaluation is a form of "protectionism" and shouts let my neighbors be damned, but devaluing a currency often fails to address the root cause of economic problems.

Just printing more money is not sustainable and little comfort should be garnered from assets or pensions being pegged to future inflation because promises can be broken and rules rewritten. When it comes to the future of the dollar one thing is perfectly clear, it is not carved in stone. It will be the result of manipulation and reaction to reactions by all the players with input into this massive market. Recently the major world currencies have been trading in a narrow range as if held in limbo by some great force. This has allowed people to think we were on sound footing as central banks across the world continued to print and pump out money chasing the "ever elusive growth" that always appears to be just around the corner. Still remember the major currencies have made multi-year highs or lows depending on the match-up and this is a big red flashing signal of instability. The strengthening dollar may be sending the warning the whole system is about to become undone because many countries are buried in debt they can never repay at real market interest rates. 

A Bloomberg article by October of 2014 looked into how Federal Reserve minutes showed officials were concerned about our stronger currency and the risk it posed to the U.S. economic outlook. Afterwards, the greenback weakened  as futures traders lowered bets the Fed will lift interest rates. This brought a consolidation and a brief period of stability, but overall, the bull rally on the dollar is still intact. I contend that a rise in the dollars value will overwhelm efforts by central banks to reinforce feelings of economic stability by keeping currencies trading in the "quiet" range that has allowed them to continue printing and pumping out money. Because of weak demand for goods little reason has existed for investors to guide this money into investments in buildings and equipment, instead much of it has flowed into intangible investments. This is the reason inflation has not been a major problem and explains the surge of stock prices to all time highs.  

When investors become unwilling to buy the bonds of heavily indebted nations the bond bubble will burst and the values of currencies in those countries will tumble bringing the stock markets down at the same time. The yen and the euro are in serious trouble, and the pound is very vulnerable to contagion. The path Janet Yellen has continued down is reckless, what the ECB and BOJ have done is criminal. With this in mind remember the collapse of any currency causes wealth to flee both from the country and that currency and seek any safe haven in reach. The bottom-line is that while many people go about their daily lives giving little thought to currency valuations they leave themselves open to the whims of those that control, manipulate and play in this important area of the global economy.  John Maynard Keynes said "By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens." While there are not many Bond Vigilantes there are a slew of Currency Vigilantes and they are ready to make their presence known.

Currencies are a tool by which wealth can be transferred, it is a Trojan horse that often goes unnoticed until it is to late. A ten percent move higher or lower against a foreign currency can have a great deal of impact on how your net worth stacks up against someone across the world. This rapidly becomes apparent to anyone doing a great deal of travel  and highlights why all of us should be very concerned where we stand when the smoke clears from the currency wars before us. Do not underestimate the forces in play. The central banks have promoted the the myth that advanced Democratic countries are immune to hyperinflation, but this myth will be destroyed as the value of the yen or euro spirals downward, soon after that people will realize that no currency is safe when it falls from grace. The country most vulnerable to a currency collapse is Japan which faces a wall of debt that can only be addressed by printing more money and debasing the yen.  Because of its size people forget that Japan is the worlds third largest economy and as a huge economic power when Japan crumbles it will be felt across the world. 

The U.S. Dollar has broken out against every major currency at a pace not seen since the 2008 crisis and remains within reach of its highs.  Its jump that began in mid-2014 was the biggest since the financial system was in a free-fall. The world is currently engaged in a massive game of speculation and chance that contains a lot of risk. This is a bubble manipulated higher by those with money chasing returns and taking on risk in a low interest rate environment. This massive misallocation of capital will come back to haunt investors and the dollar and currencies are now moving front and center. It appears the dollar has been in a consolidation period and when the next leg up begins risk will dramatically increase. This could signal the onset of the next global crisis to which 2008 was just the warm-up. Political considerations and insider deals between both nations and Central Banks play a big roll in this game and even after many countries have reduced their holdings in dollar reserves the dollar still carries a major wallop that will effect everyone going forward.

Footnote; Your comments are welcome and encouraged. If you have time please check out the archives for other post that may be of interest. In an article published in Sept. 2014 titled "Caution Alert, Currencies May Get Wild" I wrote about how markets show no mercy when a major currency shift occurs and how the falling value of both the yen and euro have the potential to reek havoc through contagion. Today we live in an age when billions of dollars can be traded in just the blink of an eye, imagine how fast things could go to hell in an environment like this. The link is below;


  1. Bruce recent reader of your blogspot. Whats you take on how this going to unfold?

  2. Watch for the yen (which is very close to making a multi-year low) or the euro to hit the skids. If either turns into panic selling it could result in diminished faith in currencies and contagion that will result that sends money rapidly seeking tangible assets. Below is an article exploring how this could lead to a new world currency.

    1. This article is garbage. I can prove to you with facts that the Euro is a better currency then the dollar.

      -The Eurozone is a net creditor with no trade deficit
      -The Eurozone has more gold then the US
      -More people use the Euro then the dollar
      -The EZ has less debt and less future debt combined then the US
      -Greece is the Euros smallest member and its biggest problem
      -California is the dollar blocs biggest member and biggest problem
      -The EZ periphery 5 now have a positive trade balance
      -The ECB marks its gold holdings to market every quarter. Chew on that fore a minute. How will a gold binge effect the ECB balance sheet compared to the Feds \?

    2. M, in response to both your comments, this one and the comment made several minutes later. It is important to recognize that a great deal of the dollars value is based on the liquidity and size of its market. While I appreciate your take on the Euro I must beg to differ. I stand with those who feel it is a poorly conceived currency and while you mentioned Greece you failed to recognize countries in the European Union such as Italy.

      Italy is the third largest economy of the Euro-zone after Germany and France, unfortunately it holds the largest public debt totaling over 2 trillion euro. While I love traveling in Europe I also see a group of nations that talk, and talk, and talk, but fail to take action. The banking problems of Europe are massive and the ECB has through its policies shifted the debt of both, the banks and Greece from the private sector and onto the shoulders of the public sector.

      The euro has no real bottom-line or solid backstop and as with other currencies its value is based on a system of faith. Under stress if the Euro-zone begins to unravel it will leave those holding its currency in a precarious position. As to why the euro is currently as strong as it is you can thank cross border currency swaps and several other temporary factors. Below is the link to an article about Italy with a chart showing Euro-zone countries debt to GDP ratios.

  3. Why do so many people think the Yen will collapse first? Most of the debt in Japan are sold to its own people - unlike Indonesia, Thailand in the 1998 Asia financial crisis or Argentina or even the 'mighty' USA. That is, Japan does not owe much to foreigners. It's not a debtor nation. It's the Japanese government owing its own people money.

    1. It is very true that the Japanese own most there debt and it is a society that has a very "think the same mentality" but at some point the reality of just how massive the dept Japan carries will begin to sink in. When the people of Japan begin to realize they are marching in lock step over a financial cliff faith will be lost and a crisis will develop creating a yen selling loop that feeds on itself.

      Recent news out of Tokyo that could further erode the value of the yen received little attention. The announcement concerned Japan Post Holdings, the world’s biggest holder of Japanese government bonds after the Bank of Japan. With little fan fair Japan Post said that it will significantly alter its investment strategy as the state-owned group revamps its 300 trillion yen portfolio.

      As Japan Post reallocates its portfolio. The move will likely to shift a bulk of money from JGBs to riskier but higher-return assets like stocks and foreign bonds. In doing so I contend this will cement an attitude within the Japanese population that it is time to start shifting savings out of the yen and into other type of holdings. This may someday be looked on as a watershed event as to how the Japanese shift away from the yen to protect their wealth. More on this subject in the article below.

  4. So Bruce you think that there will be a currency crisis including the dollar or do you see the dollar as a haven for other currencies? I am not sure why the FED would want to lose control of the money supply, too much power.

  5. I see the dollar as the safe haven near term, but a strong dollar will cause massive economic havoc. In my opinion the Fed will not abdicate its control, but history shows at some point power will shift and a replacement will be named. When the time comes expect those in power to sell the replacement as our best option going forward.

    1. The dollar was falling every day with the US indexes since August. And the Euro was rising on those days. The dollar is a risk asset now. The Euro is the replacement.

  6. Bruce, what is your take on bitreserve?

    They use bitcoin as their credit clearing mechanism into and out of a 100% physical reserve and transparent banking system. The whole business model is just based on transaction fees. It would seem to me, absent the current monetary oligarchies making it illegal, the perfect solution to the over concentration of the money power in the hands of few?

    In fact this basic banking/monetary model can be duplicated by anyone with access to the internet, a cryptocurrency protocol and a vault. Perhaps this will emerge out of the ashes of the existing banking order out of desperation of various communities to restore a money system? In fact it would work in Greece right now. Perhaps the future of money is not centralization but decentralization, just like how more people get their new via the internet and not old media.

    Hope springs eternal.

  7. Currently I'm big on tangible assets in my control that the government will find far to cumbersome to grab. Below is an article about why these things should retain value and could do very well if the economy heads south.

  8. What all this leaves out is that even in a total collapse there will be residuals. The tools to make semiconductors will not be going away. The knowledge of how to make steel will not go away. The fact that cannabis cures (at least some) cancers will not go away.

    What the worry about is money. Real wealth - the ability to keep living - is not going totally away. But because of excesses it will be reduced.

  9. Hello M. Simon, sorry it took so long to say you have a point! The crux of what is before us may hinge on relevant value rather than inflation or deflation. It is possible this is more multifaceted than most people realize and we have been mislead into arguing and debating the wrong issue or are viewing the subject in the wrong light. Below you will find a few thoughts on this subject.