In the past four weeks, the dollar has surprised many people by staging a broad-based bounce. I wasn’t among them.
For more than two years, every time the dollar has turned down, there has been a groundswell of pontifications about its imminent demise.
In the past few months, that sentiment was, perhaps, most pervasive.
As certain as those zealots were who predicted the world would end last Saturday, so have been those who have predicted the end of the dollar.
But this type of frenzy and hysteria is nothing new. Not for the dollar, not for financial markets. In fact, it’s typical of every boom and bust trade. And it’s typical of every market that reaches a major turning point.
I was recently reading an old TIME Magazine article titled the “Shrinking Role for U.S. Money.” The date: October 1979.
Some of the outtakes read …
“Once again, greenbacks were being sold off heavily in world markets in exchange for more robust currencies.”
“As the dollar is being eased out of the cornerstone position it has held since World War II, gold and some strong currencies are moving in.”
A Bundesbank leader said the world is “moving inexorably toward a multicurrency arrangement.”
Sound familiar?
Also mentioned, a bestselling novel, The Crash of ’79, that laid out a tale of the destruction of all of the foundations of industrial society as nations returned to barter economies.
All of this was written and said as the bottom in the dollar was already in place.
Measured against a basket of major currencies, the dollar bottomed in October of 1978, languished for about a year, and then proceeded to double in value over the next six years. Of course, there were major political and economic challenges at the time, and uncertainties along the way. But the point is, despite all of the panic and doomsday scenarios, the dollar didn’t go away! To the contrary, it remains the most important currency in the world today.
Fear, Greed and the Dollar
We have plenty of recent examples to reflect on where investor behavior can overpower all economic fundamentals. Many times, it’s driven by herding. By that I mean, often times overwhelming emotions of fear and greed can drive individuals to seek safety, or hope, in numbers. And we’ve seen plenty of that in recent years.
There was herding in the tech boom. There was herding in the housing boom. And the clear lesson everyone should take away from the pain of the tech bust and housing bust is that when most people think “this time is different,” it’s a good bet that it’s not!
The same goes for the anti-dollar trade. And because markets in this environment have become so correlated, swinging between fear and greed, fearing a destruction of the dollar has also meant grandiose dreams of huge returns in contra-dollar assets (metals, other commodities, foreign currencies, stocks) — creating herding across asset classes.
Take a look at how heavily positioned against the dollar market participants were going into the first of May, as measured by the CFTC Commitment of Traders report.
You can see in the light blue shaded area of the chart below, the extent of positioning in the dollar.
Everything above the zero line on the right axis represents a market that is net long the dollar. Everything below that line represents a net short position. From that, you can see the net short position in the dollar was at its most extreme for this seven-year-plus window, coming into the month of May 2011.
You can also see how the dollar index (the dark blue line, measured by the left axis) tends to respond in these overstretched periods — where market participants are leaning so heavily in one direction: The dollar tends to revert, marking turning points. And in recent years, within the crisis era, these turning points have resulted in violent swings in the opposite direction.
The Dollar—
Still the Best Alternative
I’m not joining the debate here about the inflation outlook, whether hyper-inflation, tolerable inflation, low inflation or another bout with deflation lies ahead. When it comes to currencies, it’s all about relative value.
Given the outlook for sovereign debt defaults to occur and spread across Europe, and for a dangerous slowdown on tap for Chinese growth, expect more and more global capital to move back into the dollar as the best, safest alternative.
My view: The dollar isn’t going away anytime soon. In fact, looking back over 40-years of cycles in the dollar, I expect it to have a sustained, strong rally over the next several years.
However, if you want to know about a currency that’s truly at imminent risk of going away, read my column from May 14 on the euro, the second most widely held currency in the world.
Regards,
Bryan
{ 23 comments }
I disagree with your assessment. The dollar rally looks like it’s over. UUP rallied to it’s 20 day EMA, hit strong resistance and formed an outside bearish candle stick. The Euro on the other hand dropped below it’s 20 day EMA but quickly recovered and is now trading above it. China is dumping U.S. treasuries and buying European debt which will help the Euro and hurt the dollar. The ‘dangerous’ slowdown of Chinese growth you refer to is a drop from 10% to 9% growth. The U.S. is going through a weak economic period and U.S. government debt problems are coming to the forefront of the news. There’s a good chance Bernanke will keep QE going. Expect the dollar to go lower. Even if it manages to rally there is huge resistance at 22 which used to be long term support. Expect more capital to move into gold as it has been rallying on days when the dollar was up or down.
I agree with King Ralph . There is a huge difference between 1980 and 2011, and there is a huge difference between 2008 and 2011 , as in trillions and not billions.
Wrong! Everything always follows the same economic cycle. The dollar will rebound hard straight up. The commodity manipulation will cause that bubble to break. Those shorting the dollar are being set up for a wipeout. These economic cycles always follow the same path. Those who follow the herd get wiped out. Those who go against the grain become rich. In the next few years, those holding the dollar will prosper. Those holding commodities will be crying a river of tears.
Yep. When 95% of the trading/investor public is bearish the dollar, you gotta wonder who’s left to push it down any further. Same with gold in the opposite direction; when 95% are bullish gold there’s no one left to push it any higher. I tell my friends, “When you hear continuous advertisements on news talk radio to buy gold, it’s time to sell it.” Certainly the folks paying for those advertisements are wanting to trade their gold for your dollars!
I’m with Brian, the herd is chasing after an illusion. Gold was demonitized permanently 40 years ago. In a fiat monetary system the medium of exchange is dictated by legal tender laws not gold and silver bugs.
The Euro is a flawed currency. Fiscal union cannot exist without political union. That is why the periphery countries are all going bust and a banking crisis will soon emerge.
The U.S. being monetarily sovereign does not borrow that which it alone can create. It simply exchanges interest bearing assets (bonds) for non interest being assests (dollars) to control the fed funds rate.
The debt ceiling is nothing more than a carryover from the days of the gold standard and a convertable currency.
That standard went away 40 years ago.
Take the time to read Randell Wray and Warren Mosler and learn how the monetary system actually works.
Good day.
I think you meant to say “Political Union cannot exist without fiscal union?” Otherwise the single document protocols that support the Euro concept are a thing of beauty from a conceptual viewpoint. Given Europe’s historical method for dealing with disputes (war) I believe one must admire the work of Robert Mundell Phd Econ. Nobelist, and those others that worked diligently to create a unified concept.
I wonder how many Americans realize just how disjointed the “United” states really are from an economics standpoint..:-) cheers
Brian,
You make a lot of good points in your article but I feel you overlook one important point; that is don’t fight the Fed. With Mr Bernanke in charge and economic data still lukewarm I think it is a fair bet that another massive round of dollar printing isn’t far away. Once this starts I feel sure we will see the dollar index start to fall again against the majority of currencies. While you make valid points about what the dollar should be doing from a cyclical standpoint, there is no doubt that the most powerful man in the world (Bernanke) will do all he can to ensure the opposite outcome. Only when the printing ends and the US economy has sustainable, unaided growth will we finally see the major dollar rally you seem to be expecting. In the meantime I think you are going to be disappointed.
It appears that you are at odds with some of your colleagues; notably, Larry Edelson, Mike Larson, & Martin Weiss who consistently declare the dollar to be in a decisive bear market. Am I missing something here?
I do totally agree with you that might be the bottom of the dollar, I have always maintained my password as a greenback admirerer that password still exists as well in weiss or all over the world, my question is does the US DOllar ever enter the Fountain of Youth, to regain all that lusture lost …. best and warm regards Lily
Rich, I absolutely agree with you at least over the short to intermediate term. Based on my economic fundamental, technical and cyclical, fact based, analysis of the world and US economy, I believe that the US (and possibly a good chunk of world) economy is mirroring the Great Depression or the declined Japanese economy OR a hybrid of the two. IF this is the case, then, I expect to see the stock & commodity markets correct, similar to mini 2008 situation as we come off this bear market “bull rally†from March 09. And, guess where i believe this capital will flow, just like in 2008, US Treasuries and US Cash. Why? because this is the “perceived flight to safety tradeâ€. Why? because this is EXACTLY what happened during the Great Depression. Scientist and Financier Alfred Lee Loomis and his Brother-in-law Landon Thorne sold their equities in 1929 and invested in Long Term US Treasuries and did extremely well as the Bond Market returned an average of 6.03% during the 1930′s. You could also have done well with Gold (ie. Homestead Mining Going Up). IF we are mirroring the Japanese Market, you know that the Nikkei is down over 75% over 22 years!. But, guess what, not if you invested in JGBs over this timeframe. And the story gets even better, by having the equity markets and commodity markets (excl. Gold) get sacrificed ,either implicitly or explicitly, this will bring down the cost of food/energy and all great for the poor and middle class America and world. By the way, most of the middle class is not heavily invested in equities like 5-15 years ago, so they and the poor would not be effected by a stock market correction. Also, it gets better, by having capital flow into the US Treasuries, this will keep interest rates low, also great for residential/commercial real estate and for businesses. Looks like this is already in play, as Treasuries have been going steadily up for 3 months now, while equities are struggling. Also, even better yet, it takes the pressure off of the Fed to raise interest rates and issue big a QE3 at least not for the next 6 months,allowing time for the government to get right sized AND allow the private sector to grow us out of this “Great Recessionâ€. The Fortune 500 ARE SITTING ON A TON of cash. You see, the EU and the EURO are THE problems RIGHT NOW. Also, Japan is now even worse off with the natural disaster, China has a big bubble in residential/commercial real estate that WILL burst and, of course, we have the Middle East Crises. So, guess where the intermediate and long term place to invest will be? You got it, the USA and probably Canada, as we will be the first to recover. Remember, the bond market is 2-3x the size of the stock market, so a bond market crash would put the whole world into a depression within weeks, so I don’t see this happening and I dont think the Lord will want this either. To prove my point with FACTS, every time over the last several years the down plunges by over 150 points, the US Treasuries do the best. I see this time and time and time again. And if we get a big correction,(deflation trade) like we did in 2008, this is EXACTLY what I see will happen. This is the best way out of this great recession and least painful way out of this recession for the US. Thus, as I have said for 18 months now and counting, we will NOT have a bond market or dollar crash. However, I would strongly use caution to invest in City/Muni/County/State/Sovereign Bonds of other countries as they are going thru austerity right now and either dont have a printing press AND/Or are not the world’s reserve currency.
Again with the technical analysis rather than the fundamental analysis. It’s as if you’re taking the patient’s temperature and claiming that the problem is that he has a fever. Really? What’s causing the fever?
Are you taking the position that shorts on the dollar are driving the value of the dollar? Sounds like the tail wagging the dog.
Yes, the dollar bottomed in 78 … but why? Had Volker not abolished negative real rates, the naysayers would have been correct. Greenspan and Bernanke have brought negative real rates back in vogue, and the talk of gold and moving away from the U.S. dominated reserve currency status has returned. Gold prices will climb and confidence in the dollar will decline so long as negative rates are in place. The question then will be whether Bernanke will have the steel the Volker did when the time comes.
You got one thing right, that it’s relative value of the currency. All the fiat currencies are dropping together, just some faster than others at times. Who’s buying gold instead of dollars? Any country with a negative real interest rate, including the U.S.
The below comments are mine from another blog (Larry’ Edelson’s) Whose opinion almost diametrically opposes that of Bryans. The dollar will recover in time and like Bryan I believe this current bias against the US dollar, is nothing more than fear and speculative driven nonsense. Tough times are still the vogue but the worst is behind. My fear is that the idiots in the political arena will not get down to doing the business of their nation, as is occurring in Europe and all other sectors at this time. Inthat we could see a longer recovery period than necessary.
I would like to also pose another question: Anyone may answer of course. On Gold.
Since Gold has become basically another asset class as opposed to it’s once safe bet against inflation. What happens to it when inflation returns and interest rates rise, which the Fed will inevitably need to do to counter inflation?
Do you hold that when inflation rises, asset prices naturally fall, or are you not a believer in this generally held economic opinion? That is as an “asset class†then gold must drop when inflation arrives. By how much and how fast remains nothing more than opinion I believe?But I am convinced that Gold is excessively overbought and severely overpriced and the speculators will run for the hills at the first sign of increasing linear inflation!
further comment, same source;
……………That the “punditry†still emphasize “buy Gold†is reason enough for one to begin to question the folly of ‘ following the lemmings’ over the cliff! Logic is fast becoming a scarcer commodity than Gold in this ‘ run for the hills ‘ dynamic.
People need to relax and realize that these tumultuous times while fearful, are simply transitional. They are not the end of the world as we know it! That did almost occur several years ago now. That was the time to buy Gold. When Paulsen was on his knees begging for a bailout of the banking industry! I too recommended Gold back then, when it was a reasonable price and offered sensible security against the oncoming tsunami of the trickle down disaster………..
Given the Global expansion it is possible that a new approach to currency leveling may well occur and perhaps even a new unit of trade be developed. But it would hardly make sense to use any other base unit as a replacement of the US dollar. Since, regardless of all other factors, the US economy is still after all the largest in the world by a significant margin! Fear is the enemy not the reality. Bryan has my vote.
Least ugly will win the day up until Spain defaults. Too many US banks exposed up to their eyeballs in Spanish debt. Spanish default along with recognition of the China bubble with be your black swan.
I think this broken record warrants repeating as all you commentators missed this crucial point:
The US Dollar index uses no real benchmark. It only compares the Dollar to other currencies and, therefore, seems utterly useless.
If you hold a beauty contest in a pool full of ugly ducklings, the least ugly one wins.
All currencies are only pieces of paper with numbers printed on them.
William
Sorry William: All currencies, while perhaps made of paper, still represent promissory notes secured against the combined wealth of the issuing nation. As such, their valuation dynamics are still the ruling format for indication of a nations stability and ability to create wealth. It is why I will not agree that the Euro is dead, nor that the US dollar is following it in some quasi suicide pact or other such nonsense.
I’d bet on the US economy over the long haul, as having the best chance of a viable return to significance and Global leadership. It will never be the dominant force it once was, nevertheless, to ignore the largest economy on the planet and it’s presence on the road to Global recovery, is to do so at one’s peril. Gold or any other helter skelter fear induced speculation is just that…. the temporary insanity of capital looking for security. Fear William is not a commodity, nor is it a relative factor over the long term!
Bryan says “But this type of frenzy and hysteria is nothing new.” I agree that herd frenzies and hysterias are nothing new but what Bryan fails to recognize is the undeniable “newness” of the national debt (up 60% in the last 5 years) and the unprecedented increase of dollars in the money supply. This can only lead to staggering inflation with gold as a store of wealth (not an asset class as James claims). William is correct. It is obvious that the dollar occasionally rise to the top as the “cream of the crap” among fiat currencies.
Peter. I think we could debate all day as to Gold being or not being an asset class? My question was predicated upon the very matter of the encroaching tsunami of inflation, as you posit also. That is that Gold has been also singularly attractive, due to low or non existent interest rates, which allowed a borrower/speculator, to exchange his currency power for non or low interest loans to buy Gold. What happens when interest rates begin their inexorable rise as the inflation waves increase? That is the base of my question? Your comment does not address that core premise of my question nor does it explain what good gold is, if it is not an asset class?
HOW CAN ANYTHING CREATED OUT OF THIN AIR ,MADE OUT OF PAPER OR JUST LITTLE DOTS ON A COMPUTER SCREEN , BACKED BY ONLY THE WORD OF A SMALL GROUP OF LIERS BE THE BE ALL AND END ALL OF THE ENTIRE WORLD , 42 YEARS OF LIVING ALL OVER THE WORLD AND I CAN SAY ,ITS OVER FOR THE DOLLAR , ITS A FINANICAL CANCER EATING AWAY AT THE WORKING WORLDS HARD WORK AND LIFE SAVINGS , AND THE WORD KNOWS IT , THE ONLY PEOPLE WHO DON;T ARE THOSE IN WASHINGTON AND WALL STREET ————THEIR IS IS ——-LET IT BE!!!!!!!!!!!
Dear Bryan:
I usually agree with your position on the Euro and other currencies, but it seems to me that you are overlooking some fundamental economic principles concerning the future of the dollar. One of those fundamental principles which applies to all currencies at all times, is the quantity theory of money. In the current article you said “When it comes to currencies, it’s all about relative value.†In reality, it’s all about the ratio of the quantity of money to the quantity of commodities — period. When the quantity of money increases faster than the quantity of commodities, prices inevitably rise. This is proven conclusively by thousands of years of government’s meddling and manipulation of money. We could go all the way back to Hammurabi’s Babylon (2123-2081 B.C.) and his experiment with a dual currency, silver and barley, complemented by extensive wage and price controls. But this is not the place for a historical review of money manipulations.
The thing that confuses this issue is the time delay between cause (increase in the money supply) and effect (rising prices). For example: prices today are more than 25 times higher than they were in 1937. Since prices can not be sustained at a level above that which the money supply can support, the conclusion is that the money supply must have also increased by a factor of 25, otherwise there would not be enough money to support the higher prices.
However, the quantity of fraudulent money created by the Federal Reserve System’s legalized counterfeiting operations since it began operations in 1914, has been much greater than is reflected in today’s bloated prices. A very large amount of the money created since 1914 has not stayed circulating in the U.S. This is because of the international reserve status of the dollar, the trade deficit (which alone is over $7 trillion), U.S. foreign aid programs, bank loans to foreign countries, and many other methods of placing dollars in foreign hands. I doubt that anyone really knows the total amount of dollars floating around in foreign hands but it’s a huge amount. This has kept prices in the U.S. much lower (and the value of the dollar higher) than they would have been if all that money had stayed home. During its first six years of operation (1914 – 1920) the FED more than doubled the money supply (126.7% increase) – see “Economics and the Public Welfare†by Dr. Benjamin McAlester Anderson, © 1949, page 26.
This expatriation of dollars has resulted in approximately a 90 year delay between cause (increase in the money supply) and effect (rising prices). However, not all of the money in circulation today was created between 1914 and 1920, money creation has been continuous since 1914 and therefore we can’t say that the total delay has been 90 years. The point is that today’s rising prices are the result of PAST money creation by the FED, not Bernanke’s present profligate money creation. Prices will rise (the value of the dollar fall) at some time in the future as a result of Bernanke’s present money mania. Many FED bank Presidents have stated that there is a delay of approximately nine months to a year-and-a-half between money creation and rising prices. However, it may not be that long due to the dollar flooding into the country from foreign hands.
There’s another fact that should not be overlooked when evaluating trends in the dollar’s value. When new money is injected into the economy it drives prices up, and the value of the dollar down, because of the quantity theory of money as explained above. Higher prices caused by the previous injection necessitate an even larger increase in the money supply for the next injection in order to prevent economic collapse. Obviously it requires more money to pay the higher prices to just maintain the status quo without a boost in the economy. Thus each new injection necessitates an even larger injection in the future. This cycle repeats until the dollar becomes worthless, or is replaced by another fiat currency which my delay the inevitable but will not prevent it. This is exactly what happened to Germany between 1914 and 1923 when the mark completely collapsed. In my opinion, today’s dollar is in about the same situation as the 1920 German mark. But the time required for Germany to arrive at the final hyperinflation stage in 1923 may have been longer than it will be for the U.S. In spring of 1923 the German Riechsbank began hiring private companies to assist in the enormous printing operation and by November they had 132 such firms helping print money. In November the combined output of the Riechsbank, plus the private printing companies, amounted to 397,833 quintillion marks (397,833,000,000,000,000,000 marks). Today we don’t have the limitation of printing press operations, we create money by entries in computers which is a much faster method of expanding the money supply.
Another problem with trying to predict timing is that the government’s, and the FED’s, money supply statistics are vastly understated so we don’t know exactly how much money has already been created.
The final conclusion of all this is that the dollar, or any fiat money that replaces it, will follow the German mark into oblivion – in other words to zero value. However, in the meantime, the value of the dollar in FOREX markets will undoubtedly fluctuate. But the long term trend (which may not be as long some people think) will inevitably be down unless the Federal Reserve System is abolished immediately and U.S. governments (federal, state and local) adopt a balanced budget policy. But I don’t see any indication of a trend in that direction. I’m well aware that this will raise many questions such as what would replace the FED? But answering such questions would require an explanation of free market banking operations which is not practical here.
Attempts to created wealth by issuing fraudulent money always fail. Our attempt will suffer the same fate because of fundamental economics. This is not a matter of personal opinion but simply an application of fundamental principles.
Bill Denman
Bill Denman,…..
“……….In reality, it’s all about the ratio of the quantity of money to the quantity of commodities…..”
What ? How about the base economics of Global supply and demand as it relates to currency stability? Your basic comparative historic premise is in error. This appears to be the constant argument of the libertarian approach to economics? Perhaps if we all go back to horse and cart and candlelight, your premise might have some validity? Todays modern economic concepts must remain flexible and reactive to the basics of Global supply and demand, not just the jingoistic beliefs commonly and previously held by nation states.
As an aside. There may well be a new trade unit of currency in the foreseeable future, but never discount the influences of the worlds largest economy (USA) and the underlying value of it’s unit of currency in the designing and core value of any new trade unit.
I agree with Bill Denman for a couple of reasons he mentioned and for a couple of reasons he didn’t. The ones he mentioned are self-explanatory.
What he didn’t mention is that central banks worldwide are on a gold-buying spree–even little countries that make up frontier markets are buying it up. One has to ask why they’re buying gold and not the dollar. Even with this slight uptrend in the dollar, the currency exchange rates are set to be more costly to buy dollars–meaning: no one wants them!
Moreover, countries are dumping our treasuries–I believe China has done this for six or seven consecutive months! In addition, the BRICS (Brazil, Russia, India, China, and South Africa) are bartering for oil trades instead of using the US dollar. Thus, we are losing our world reserve currency status in a slow death.
It is possible, however, that the Fed would want to recoup it’s purchases of the US debt and keep the upward trend in the dollar. Yet, with the notion that QEIII is right around the corner and all the gold they’re sitting on, it seems the Fed can be patient for the exchange into a new world currency.
Lin,
My comment to Bill Denman could also apply to your remarks. That the US dollar is in a “less than favorable” position has more to do with the realignment of economic modeling for the new Global realities, and less to do with any core mistrust of the USA as an economic entity. My remarks as to a new unit of trade/currency also apply in this regard.
There is however, substantial concern with the lack of commitment by the US congress etc about stabilizing the national economy, and that causes the speculative and political fervor and the drive to secure the alternate hedge of Gold. This political pressure on the dollar dependent economies, is as I said in my previous comment, simply a matter of transitional effects, and demands for a more significant role for the emerging economies led of course by China and India! It is not a matter of localized economics in other words. This my comment as to the Lemmings.
Greetings James Covey, your commentary was a breath of fresh air for me. I’ve been struggling with the barrage of opinions that I get (some I’ve paid for) about how to preserve wealth in today’s economic climate. While most have an eloquence about them and tend to sway me, I’m left with a haunting feeling that the overall message of an essay is flawed in its reasoning or by prejudice. Untrained in economics it’s difficult for me to pinpoint why. Then I feel powerless. Your writings seem perspicacious and free of agendas to me. May I be so bold as to ask what your current strategy is to prevent loss by inflation whilst minimizing risk? Gold vendors tell me that a safe level of gold investment is about 5-10% of one’s portfolio. Even if gold is an amazing safe haven, I wonder what about the other 90%. I would rather have 90% of my assets in well-reasoned safe investments and 10% in gold as a speculation. I would really appreciate any light you can shed on how to act on the scenario you present. John