Tuesday, May 8, 2018

Stronger Dollar Is A Problem For Global Growth

Near the end of 2015, I wrote a piece that indicated a great deal of wealth would be flowing into America seeking protection from the ravages fostered upon it. A great deal has happened since then. Between Trump and many others talking down the dollar, the threat of trade wars, and the introduction of several cryptocurrencies the dollar has backed off a bit. Still, the dollar remains relatively strong and has again started to strengthen after the euro experienced a bit of strength based on the false narrative Euro-zone growth would be picking up. As for the yen's strength, I feel much of it has to do with money leaving China via Japan. Still, the dollar remains strong, this is driven by the fact many countries have even worse policies than those America's leaders have chosen to pursue.

Huge Number Of Short Positions Against Dollar Exist!
The world is currently engaged in a massive game of speculation that contains a lot of risks. A massive number of short positions have formed against the dollar which will cause it to strengthen as they begin to unwind. A stronger dollar acts like a magnet pulling wealth towards America and away from countries already having problems. If this turns into a self-feeding loop the dollar may soon get much stronger. Throughout history, strong currencies have attracted wealth and this means money and wealth from all over the world could be headed towards our shores. The money coming into America would flow into both bonds and stocks supporting lower interest rates and the stock market. Those of you who have read other articles I have written know I think the market is overvalued and the bond market is a bubble ready to pop, but as long as we remain the best and safest place to hide money do not discount the dollar.  

The dollar is the linchpin of global finance 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.  Markets love stability and stable currencies because 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.

Currencies are under assault in places where the economy is weak and the issuer is buried in debt they can never repay at real market interest rates. As the excessive flow of cheap U.S. dollars into emerging markets suddenly reverses and funds return to the U.S. looking for safer assets the pressure is ramping up. The central bank “carry trade” of low-interest rates and abundant liquidity used to buy “growth” and “inflation-linked” assets in emerging markets is unwinding. A global slowdown combined with rising interest rates in the U.S. and the Fed’s QT (quantitative tightening) has resulted in emerging markets losing their lifeline of inflows. These countries now face massive outflows made worse because they have squandered much of the inflows over the years rather than using it to strengthen their economies. The Argentine peso, Turkey's lira, and the Russian ruble are examples of this. Many Latin American and emerging market economies are also in this trap. The high fiscal and trade deficits financed by short-term dollar inflows have turned into time bombs.

We must add the stronger dollar to the problems the Federal Reserve and its new Chairman, Jerome Powell face at home because it threatens the global economy. Part of the current Fed strategy to ease this pressure has been to whack at the idea interest rates will soon rise but lately, the dollar has been edging its way higher and predictions of strength or weakness to come are in full swing. With this in mind, the central banks appear to be making every effort to reinforce feelings of economic stability by keeping currencies trading in a "quiet" range. It is in their advantage that people think the global economy is on sound footing as central banks across the world continued to print and pump out money in search of the "ever elusive growth" that never quite arrives.

Drawing Money Like A Magnet
Do not underestimate the power of cross-border money moving into a country as a powerful economic force. While the dollar has been described recently as the cleanest dirty shirt in the closet, or the best house in a bad neighborhood, both place it as the least worse option. The reality is other options fail to pass the smell test. This means what is coming to America is wealth and money seeking a "safer" place to take refuge from the coming storm. Today America has become a money magnet, Lady Liberty the symbol of America that stands in the harbor of New York while a bit tarnished is still giving people hope even if Washington is not overwhelming us with the same glowing feeling.

The dollar has a huge advantage over other currencies because of its role as the world's reserve currency. This makes it the "default currency" and by the size of its market, float, and liquidity the currency by which all others are weighed, measured, and often pegged. The chickens are coming home to roost for countries that face growing debt and policies that make them uncompetitive. Some of these countries are increasingly looking at ways to confiscate the wealth of their citizens, it is only logical that as people begin to realize the dead-end path taken by their homelands they take action to move their money to a safer place.  

Very Important Chart In Understanding The Dollar
The chart to the left is very important. Today four major currencies dominate the world stage, they are the pound, the euro, the yen, and of course the dollar. The remaining currencies remain small bit players in the overall scheme of things. 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. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there is a slew of  Currency Vigilantes and they are ready to make their presence known.

History has shown countries can steal wealth by way of various Trojan horse methods such as monetizing debt through printing massive amounts of new currency or new taxes. If you look close you will see the currency markets are beginning to reflect diminished confidence in the system central banks have created and as the currency games continue to ratchet ever higher it is becoming more apparent that much of the world financial structure is built on shifting sand as the schemes bankers have used for years to hide and transfer debt are coming under attack. If the current system crumbles it will culminate in a reset of the economic system across the globe. If people all over the world try to get out of their home currencies a surge in the value of the dollar is logical. In the end, this would not be the salvation of America or its economy but it sure would create a lift that we would be wise to take advantage of.

4 comments:

  1. How would you"take advantage" of this?

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    Replies
    1. Consider finding out what to short and telling us.

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  2. Just by being an American with dollar assets if I'm right and the dollar strengthens you will be a winner. If you have a commodities account and trade currency futures which I would not recommend because they are very very dangerous and highly leveraged, you can short the euro and/or yen or go long the dollar index. Remember it is not always about making a fortune but it is often just it is just as important not to lose one.

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  3. Is it possible that the runups in companies like MELI and CPA are fraud that took advantage of this short dollar trade?

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