The US Dollar Strikes Back

Since 1913 and the creation of the US Federal Reserve, the US dollar has lost over 90 per cent of its value, in lockstep for the most part with the ballooning of the US money supply the majority of which is comprised of credit.

It hasn’t been much of a reach therefore for inflation oriented analysts to predict the eventual collapse to worthlessness for the currency.

In early November of last year, with pessimism on the US dollar near all time lows, we stated the opposite, advising our subscribers that the dollar would soon put in an important bottom and head higher. It did just that a couple of weeks later.

That call was very contrary to the majority view. There was a chorus of well known inflation leaning commentators predicting doom, using the same tired arguments many times over: the dollar is a worthless piece of green paper and foreigners would soon cease buying US debt and dump the dollar, causing it collapse.

I didn’t think the dollar was headed to zero then, and I don’t now.

The years leading up to the fall of 2007 were an inflation-oriented investor’s dream. But despite the major stock, real estate and commodity markets hitting new highs during that period, the US Treasury bond market was painting a very different picture. Contrary to historical precedent, the runaway inflation view was not held by bond rates that refused to rise.

It became evident that the enormous credit creation over many decades was fueling not only those assets sensitive to inflation concerns, but also assets whose prices should have suffered declines with the onset of a real inflation threat. That bond prices were not falling meant that there was something terribly wrong with the inflation call.

While that warning initially fell on deaf ears, it was all too clear by the fall of 2008, when deflation arrived with devastating force.

It turned out that the bond market had been right all along, living up to its label as home of the smart money. An important clue during that time was the action in the US dollar, which had started rallying months earlier, warning of what was coming.

From the stock market lows of March 2009 through the end of that year, stocks have staged an enormous rally, fueled by the hundreds of billions in stimulus programs around the world. In addition to stocks, commodities rallied as well, as did the precious metals. The US dollar fell. It wasn’t long before the inflation crowd started to drum up the same old arguments.

But late last year, the US dollar once again has turned and rallied strongly. Commodities peaked at around the same time. Bond prices started to rise and have accelerated that rise since the start of the European debt crisis. In our opinion these market turns, and most importantly the US dollar’s strength, are once again raising red flags, warning that stimulus measures are wearing off and the deflationary wave is resuming.

The European debt crisis has worldwide ramifications. A global economic recovery, the argument goes, depended on smooth running credit markets and healthy debtors. The financials were to lead the way utilizing cheap credit. That thesis has now been called into question, and in our opinion will be revealed to have been just as misguided as the effort by governments around the world to produce silk purses out of sows ears by adding onto an already fragile debt pyramid.

Gold continues to rise however, having hit news highs recently. It is profiting from the paranoia unleashed by an inflation side that insists all paper currencies will soon collapse. Gold may continue to catch a bid here and must be respected, but its march higher of late might very well turn out to be a fake-out rally, as it too will succumb in our opinion when the full force of the next deflationary wave hits.

We have stated this often but it’s worth repeating – the US dollar is rising because of depression and deflation, i.e., bad news, not good. It all depends on one’s perspective though. The US dollar has been stretched thin since the creation of the Fed in 1913 and the build up in credit over many decades, but it can snap back in a big way as US money supply contracts by way of US dollar debt defaults.

I suppose in a sense the US dollar is rising because of good news after all, since that means a broken credit machine that had siphoned off value from the dollar over the course of many decades is finally being revealed to be the culprit and destroyer of purchasing power that it was. It is about time.

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