Why Thinking Like an 'Evil Genie' Doesn't Work in Currency Markets

Well, it certainly doesn’t look all that good. That’s right, you know what I am talking about because this is the ten millionth article you’ve seen on this topic. The United States dollar. For all sorts of reasons it appears poised to, once again, drop off a cliff.

Which, personally, I’m going to say is getting like, really tedious. Now, I’m absolutely not going to dwell on all the technical trading stuff about why the dollar appears to be in severe trouble now. Look at Powershares U.S. Dollar Bullish ETF (UUP), and you get the picture. Short term trading momentum as measured by the fifty day simple moving average has dropped below long term investment momentum as measured by the two hundred day simple moving average.

On the short side, Powershares U.S. Dollar Bearish ETF (UDN) tells a mirror image story, where the short term trading momentum has burst above the long term investment momentum. I’m worried about this because based on that technical signal, a well trained monkey sitting at a trading desk would be buying UDN or selling UUP, or both. No disrespect for well-trained monkeys, but I really start to shudder when I think about what a well-trained math PhD sitting at a currency desk might do.

But as I said, that’s not what I want to dwell on at all. I’m not thinking about monkeys today. Today, I am thinking about evil genies. Specifically, what I’m all hung up on is the fact that normally, when 100% of everybody out there is convinced that an asset will go up in price, it goes down. And when 100% of everybody knows for a fact that an asset can only go down, guess what, the market proves otherwise. This is the nub of what contrarians believe, and frankly, there’s plenty of truth to it. Why? Because all capital markets are actually controlled by evil genies. It’s the only rational explanation.

And what’s the practical upshot of this incontrovertible fact? Simple. If you are an investor, you must try to think like an evil genie if you wish to make money or preserve what money you’ve got.

What does this have to do with the U.S. dollar, though? This: thinking like an evil genie doesn’t seem to work in currency markets. Now, go out and find me one person on this planet who believes that the dollar will increase in value relative to other currencies. And then give me his or her name because I have yet to find ANYONE who believes the dollar’s fate is rosy. Moreover, this pervasive bearishness has been the state of affairs for YEARS and YEARS now – at least as far as I can see. Goliath trade and budget deficits, and artificially low interest rates in the United States go back a while, and these economic conditions are by no means supportive of a strong dollar in the least.

Evil genies are not economists. They are evil. They only want to prove the majority wrong and to make the majority poorer in the process. Since the majority of people out there know the dollar will drop in value, the evil genies ought to be shoving the price of the dollar higher. And you’d think this would have played out already because currency markets are pretty skittish, where stuff happens quickly. But, surprising as it may seem, the evil genies are actually accommodating the majority view. You’ve got to wonder what gives?

I am not smart enough to say, but I can offer up some theories and leave it to you to select which explanation makes sense to you.

First, government intervention determines the value of currency more than economics. It's like, you know, a conspiracy thing.

Second, the good market fairies, who want to make as many people as rich as possible as often as possible, have displaced the evil genies in the currency markets.

Third, the silent majority is too bullish on the dollar, and only a strident minority is out there preaching doom and gloom when it comes to the greenback.

Or here’s an intriguing fourth possibility. The evil genies are waiting with uncharacteristic patience to deliver the dollar to new highs at a moment when none believed it possible. We sort of saw that at the height of the credit crisis, in fact. Last July, when the system was coming apart, the dollar began an explosive, nearly 25%, ascent through to the early part of 2009. Right as U.S. interest rates dropped to negative, and the U.S. government went on a borrowing spree unlike anything seen since World War II, sending our budget deficit into an impossible trajectory. I guess if you believe this, you could chalk this up to risk aversion – investors find comfort, somehow, in dollars and Swiss Francs. Or you could take my view – there was every reason on Earth for the dollar to have ended last July, so the evil market genies made it rally, just to humble as many investors as possible.

This is spooky. If they did it before, then maybe the evil genies are just setting us up and they’re going to pull another trick once dollar bearishness is literally universal, and the dollar will soar to new highs and completely torch over-confident currency traders like never before. EEEEEK! Oh wait, not eek – I get paid in dollars and own dollar-denominated assets, and don’t like unpatriotic people who short the dollar. Go, evil genies, go.

Finally, here is one final theory, which unfortunately is less interesting than theory number four but, possibly, more accurate. It gets back to the point that currency markets are, as I said before, skittish. Currency traders as a rule have such short term investment horizons that perhaps, the long-term (read, more than five minutes) view regarding the value of the dollar is simply a non sequitur. If the majority is not holding a position open for a year or two at a time, the evil genies can’t burn them with a surprising long-term price trend. So, maybe the interests of the evil market genies and the interests of the human race are aligned when it comes to the dollar’s long-term price trend.

I’m going with theory number five, because there is a happy moral to this story. The moral is, evil genies really only like to disprove us when they can force us to part, tearfully, with our wealth. Otherwise, they’re happy to go right along with us, holding hands, skipping playfully in the sunshine, handing out balloons, sharing a bottle of soda pop without even wiping the germs off.

Uhhhh….. wait. There’s a problem. While we’re all sharing lollypops, singing and laughing in the sunshine with evil genies, you look below your own shoes and realize that we’re all standing on the deck of the Titanic. I think I’m hearing that ominous snickering sound coming from the evil genie’s camp, after all. EEEEEEEK!

Comments

[Jasper M:]

"Now, go out and find me one person on this planet who believes that the dollar will increase in value relative to other currencies."

HEY! Mr. Trias! (*whistle*) Over Here!
(frantically waving) Oo, oo, pick me!

At the risk receiving the Death of a Thousand Thumbs:
*I* think the $US future is rosy. Not out into the indefinable future, of course; even my crystal ball gets hazy beyond a certain point. But for most of the next, say, 6 years, I think it will beat the pants of of all the majors, and all but maybe 3 of the minors.

Japan is Done. Europe is coming unglued. England has every problem we do, worse. And the Yuan is run by socialist dictatorship, which will ruin any actual prosperity that happens to arise behind their cooked numbers.
(whatever my differences with president Obama, he is nowhere near that level yet)

And my money is firmly where my mouth is. 90% in cash, which seems to buy more every month.

Credit inflations are not new. Nor are their aftermaths. The Austrian School has been addressing them for 100 years, and in detail for 70. Von Mises did not equivocate on this matter - it's All coming out.
I think the credit contraction will continue (though not necessarily in a straight line), until there is so little credit left in the system that actual physical reserve notes (which, unlike credit, are durable) represent a significant fraction of $-denominated purchasing power. That would mean destruction of 90% of the credit in the system now.

And since all the Fed's swiftly deployable tools only create more credit, they can ultimately do nothing to stop.

police verso?

Jun 03 05:13 AM

[DONE_SONZ:]

Going against the grain for the sake of going against the grain isn't always the best idea.The "evil genie"had its day in the sun already when the dollar was rising for no real fundamental reason.

Jun 03 07:08 AM

[Pat Shuff:]

Because the meaning of thumbs up/down has been reversed from the original meaning in Roman gladiator times, just assume the upcounts are well meaning but ignorant and the downcounts are from the historically knowledgeable, I do.
I take issue with the evil genie notion, despite having a role in the downfall of Rome and all roads leading fore and aft by sending down the blinding success which destroys. Pure genius, the evil lies elsewhere, in the misinterpretation of said success, by those in the spell of evil backwards.

Jun 03 08:52 AM

[Alex Trias:]

This comment gets a thumbs up from me. I do hope you are correct in your predictions. I won't quibble with the fundamental economic arguments you make because the thrust of this article, as you can tell, is not that fundamentals will cause the dollar to deteriorate. I actually have no idea whether they will or not. My concern is all about trading momentum and herd mentality, and what THAT can do to the currency. I worry that a spooked pack of lemmings can do more damage than structural imbalances can.

The larger focus, though, which might not come across, is whether there are certain markets where it pays to be a contrarian and others where it does not. Is that so, and if so, WHY?


On Jun 03 05:13 AM Jasper M wrote:

> "Now, go out and find me one person on this planet who believes that
> the dollar will increase in value relative to other currencies."
>
>
> HEY! Mr. Trias! (*whistle*) Over Here!
> (frantically waving) Oo, oo, pick me!
>
> At the risk receiving the Death of a Thousand Thumbs:
> *I* think the $US future is rosy. Not out into the indefinable future,
> of course; even my crystal ball gets hazy beyond a certain point.
> But for most of the next, say, 6 years, I think it will beat the
> pants of of all the majors, and all but maybe 3 of the minors. <br/>
>
> Japan is Done. Europe is coming unglued. England has every problem
> we do, worse. And the Yuan is run by socialist dictatorship, which
> will ruin any actual prosperity that happens to arise behind their
> cooked numbers.
> (whatever my differences with president Obama, he is nowhere near
> that level yet)
>
> And my money is firmly where my mouth is. 90% in cash, which seems
> to buy more every month.
>
> Credit inflations are not new. Nor are their aftermaths. The Austrian
> School has been addressing them for 100 years, and in detail for
> 70. Von Mises did not equivocate on this matter - it's All coming
> out.
> I think the credit contraction will continue (though not necessarily
> in a straight line), until there is so little credit left in the
> system that actual physical reserve notes (which, unlike credit,
> are durable) represent a significant fraction of $-denominated purchasing
> power. That would mean destruction of 90% of the credit in the system
> now.
>
> And since all the Fed's swiftly deployable tools only create more
> credit, they can ultimately do nothing to stop.
>
> police verso?

Jun 03 09:47 AM

[Alex Trias:]

I agree. I learned that lesson when I bought Lehman Brothers stock the Friday before the place went under. Why? Because I'm very smart, obviously! I figured nobody on the face of the Earth would buy this stock at this time, and for that reason, I knew I'd make a fortune if I did (well, not quite a fortune. I only bought $500 worth of LEH).

$500 lesson for Alex: going against the grain just because you want to be a punk is, it turns out, not going to necessarily work out any better than flipping a coin. Maybe worse.

But the question I struggle with is what factors, if any, can explain why going against the grain works sometimes, in some markets, but not others? I've tossed some theories out here, but frankly, I don't think I've gotten close to the answer yet. It's really a larger question than can be adequately addressed in a single article, but I'm guessing we might see some pretty good commentary with all sorts of ideas I couldn't come up with myself - which is the only reason I write this stuff anyway.

Thoughts?

On Jun 03 07:08 AM DONE_SONZ wrote:

> Going against the grain for the sake of going against the grain isn't
> always the best idea.The "evil genie"had its day in the sun already
> when the dollar was rising for no real fundamental reason.

Jun 03 09:57 AM

[kotika98:]

currencies are diferent - while other markets are zero-sum game in this case all the guys who are putting on bets now that the dollar declines can make money, at the expense of people who dont follow currency markets regularly and belatedly discover a year or two down the road that they should get out and invest their dollars abroad. Its when your average Joe pulls his S&P500 index fund in his IRA or 401K and puts it into BRICs thats when you know the dollar decline is done. So far only pros at endowments have put serious percentages of their portfolios into foreign markets.

Jun 03 12:35 PM

[kotika98:]

and the other thing is that the US had been running loose monetary policies since at least end of WWII, so long term depreciation of the dollar is completely inevitable - and also more or less unactionable.

Jun 03 12:40 PM

[Jasper M:]

If you question is about the value of contrarianism, let me take a different stab at it -
It is profitable to be Right. Contrarianism is just Leverage.

If you are right, but the herd is as well, your winnings are not exceptional. Ditto losses when you are wrong - if Everyone you knew bet $500 on Lehman, if would just be a funny story for you all to retell over beers.

But if you are right, and No One (or near enough) else is, you probably bought Really low, or sold Really high.
I have tasted this sweet fruit (see my profile, I won't bore with details here), And it is addictive.

Jun 03 12:40 PM

[Alex Trias:]

Yeah, in order to get at this lovely sweet fruit, you sometimes end up eating a few rotten bananas. Doesn't really bug me. I don't even try to be right 100% of the time - 60% of the time can be just ducky.

Jun 03 03:05 PM

[skye001:]

I don't know what will happen to the dollar but there are a few people out there who think it is going up --

Mike Shedlock

globaleconomicanalysis...

Mahendra Sharma

www.mahendraprophecy.c...

Jun 04 12:16 AM