Has the dollar put in an important low? It looks like it, since the NYBOT Dollar Index widened the gap on Wednesday between it and a key Hidden Pivot support at 80.04 that we drum-rolled here earlier. We had been using that number as a downside target since late April, when DXY was trading just above 84; it was first touched last Friday, then exceeded by a scant 0.23 points before bouncing back. Now, if the dollar is indeed embarking on a major rally in line with our forecast, stocks are likely to fall, and gold and other precious metals to come under pressure, for the foreseeable future. These new trends may have begun to emerge yesterday, since the Dow Industrials fell 173 points and Comex June Gold reversed a promising rally early in the session to settle more than $10 below the day’s highs.
The short squeeze that has powered the stock market’s bear rally since March 6 corresponds precisely to a period of weakness in the dollar, and that is why we expect shares to fall hard if the dollar strengthens. Why should this be so? The simplest answer is that a rising dollar is going to catch borrowers around the world with their pants down. For despite the deleveraging of the financial system that has occurred since the U.S. mortgage market began to implode about two years ago, borrowers are still caught in a vise, and the world is still massively short dollars because that is the currency in which nearly all borrowing has been done.
World Massively Short Dollars
Scores of millions of homeowners who are mortgaged to the hilt have implicitly bet against the dollar. So have financiers who have used derivatives to borrow dollars in some leveraged fashion. There are hundreds of trillions of dollars worth of these instruments still in play, most of them denominated in U.S. dollars, and if they cannot be rolled forward, the borrowers will have to settle up in cash. Similarly urgent demand for otherwise shunned equity shares creates short squeezes in the stock market all the time, and there is no reason why a fundamentally worthless dollar could not be squeezed higher by the same implacable forces.
A rising dollar is most surely not what the world needs right now, since it will increase the real burden of debt on all who owe dollars. That is the crux of deflation, not the increase in the money supply that inflationists have been blathering about for years. Who cares what the supposed money supply is? Most of the yo-yos who cite growth in the money supply as inflation per se don’t even know the difference between money and credit. You should pay them no mind in any event, since the far more important concern, at both the personal and macroeconomic levels, is whether your and everyone else’s debts are becoming easier to service, or harder. As long as the latter condition persists – and it will, unless a bailout package comes along that arbitrarily adds three or four zeros to every American’s bank account – all who owe will be subject to the asphyxiating effects of deflation.
$13 Trillion Just ‘Spit’
A deflationary outcome might seem highly unintuitive at the moment, given that the U.S. is in the throes of the biggest fiscal and monetary blowout since the founding of the Republic. But as we continue to point out, the $13 trillion that has been expended already on bailout this-or-that is just spit compared to a global asset deflation that has already sucked $60 trillion to $80 trillion of asset values into a black hole. We think this trend will continue and that asset values have much farther to fall before deflation has run its course in perhaps five or six years.
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Rick,
Your essays attract some very intelligent and thought-provoking comments. I hope that I don’t bring the “average” down.
The US Government is going to try its best to keep the checks (welfare, Social Security, food stamps, etc.) coming even after, as you write, above, the USD is “worthless scrip.” No checks —> societal chaos.
I don’t see how lending money to corporations (buying their bonds) offers much shelter. Successful corporations will have onerous, “excess profits taxes” to pay for “gouging” the public for necessities. And, eventually, the corporations will pay back the bondholders in “worthless scrip.”
My crystal ball tells me: At some point the USGov’t will “blame” the Fed for the “worthless scrip” and will follow China’s lead in having a bi-metallic backing for the New US Treasury Dollar. With the small amount (no amount?) of available gold or silver available in Fort Knox, the amount of gold and silver backing will be miniscule. Maybe the Treasury will pull a 1933 “redux” making gold / silver illegal to spend. [How well did the USGov’t respect Chrysler bondholders’ rights the other month?]
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Nothing could be more deflationary than honest money, Paul — even slightly honest money with barely a whiff of metal backing. I doubt we’ll reach that point before fiat has been repudiated, but it will take a complete collapse of the economy to bring that about. Meanwhile, as long as foreign producers continue to accept worthless U.S. paper for real goods, what is the incentive to reform? RA