Why the Dollar Likely Bottomed Last Week

It's pretty tough to find investors who are bullish on the US dollar these days. Judging from our dollar sentiment survey results last week, it seems like most dollar bulls probably read this blog!

When I consider:

• Not a day goes by without an investment newsletter popping into my email Inbox that highlights the dollar's pending demise.

• There are YouTube videos circling the internet, with guys breaking stuff in their garages while lamenting the dollar's loss of purchasing value since the gold standard was removed.

• Even Barron's is piling on, saying The Greenback Is Broken.

The dollar may very well be broken, but I can't see this decline lasting much longer with sentiment as negative as it is. Bearishness on the buck probably hasn't been this low since the last time it bottomed - which was even below current levels, by the way.

How is this possible? How could a currency as sick as the dollar rally?

It's not without historical precedent - take Japan's Central Bank, where the old joke is that they are so incompetent they couldn't even destroy their own currency.

Is it possible our Fed is just as incompetent? I wouldn't bet against it.

We're in a period of debt deflation that could be around for some time. It's unlikely that the Fed will be able to "print" enough money to create inflation this period is over.

Because with a credit based economy that peaked around $52 trillion in 2007, printing a few hundred billion here and there doesn't really "move the needle" when credit is getting wiped out at a much faster rate.

Finally, it's interest to note that on Friday, the dollar was up sharply while all major indices were also up big. That strikes me as a pretty bullish move, because the dollar had previously been getting killed everytime stocks were up.

Bottom line: Just because many pundits and experts believe the dollar SHOULD fall, doesn't mean it will. And my bet is that, at least for the next few months, the exact opposite will happen - because markets usually move in directions that frustrate the highest number of investors.

Comments

[Prudent Man...:]

The dollar, to be of value, is to be backed by value. Where is the beef? Geithner's signature on the newly printed currency?

You place your bets, smart or dumb, and take your gains and losses. No whining when the Easter Bunny lays an egg and it is broken.

Aug 10 02:37 PM

[socrateazz:]

Value is all relative. Relative to what? Relative to everything. Other currencies. other commodities, beliefs, you name it. there is some influence. That being said I agree short term a rise is likely if for no other reason most who think the dollar is going to fall have already made their bet. The probabillity is more people will change their mind toward bullishness than will decide it is time to go short. I go with the trend when there is no extreme beliefs either way. If two thirds think one thing will happen then I really believe the opposite will.

Aug 10 03:42 PM

[Jasper M:]

Well Done, young man. So few understand just how puny the Fed & Treasury's 'levers of power' are, in the face of collapsing credit supply.
I say at least 8 months of dollar gains.
Keep up the good work.

Aug 10 04:56 PM

[Bruce Vande...:]

I agree, short term, with the current deflation, the dollar will probably rise. Does this mean we can go a few trillion more in debt though? Has to be paid back sometime, right?

Aug 10 05:05 PM

[popey:]

Dead cat bounce. The dollar is cactus. So is the USA due to profligate spending and criminal indulgences at the Treasury level.

Aug 11 08:17 AM

[Asbytec:]

The author says, "It's unlikely that the Fed will be able to 'print' enough money to create inflation (until) this period is over." That's the point most miss. Jasper nailed it, too. The Fed just cannot compete with the volume of money created. They've lost control.

Frankly, this will be a drawn out "square root" shaped recovery, to credit another contributor. Debt will certainly recover, but at far lower levels than the opulent 80's and 90's. The global economy will settle into an extended period of slower, more sustainable growth with fewer dollars fueling smaller current account surpluses. We've had severe public debt before, we'll pay this down, too.

And if the dollar ever does collapse, wait and see it's affect on every other fiat currency. They're all in trouble, including the Yuan.

Aug 11 09:09 AM

[Asbytec:]

Furthermore, the entire global economy will have to adjust to less dollars. This is no short time affair, this will take a while.

Aug 11 09:13 AM

[Brett Owens:]

Thanks Jasper, Asbytec - it took me awhile to grasp the Fed's lack of money printing ability, which is a pretty compelling piece of evidence when you think about it.

I read recently that credit was $32 trillion (or thereabouts) earlier this decade, which then ballooned to $52 trillion...which means if we head back to earlier levels, they need to "print" $20 trillion (!) to keep things afloat at the same level.

Aug 11 03:09 PM

[Asbytec:]

Brett, interesting topic. It's stretches my imagination, but from books I've read it seems derivative dollars drying up globally. The dam nearly burst on all derivative money...the potential was there to wind down the money supply to what the Fed could actually print.

One stat mentioned Fed power money was as low as 8% of global liquidity. Could you imagine the value of a dollar if PE ratios fell and all money pulled out? Man, a quarter for (peak oil) gallon of gas and a house for under $100,000 like the 50's again.

Being retired, I welcome some deflation. We need some deflation. We need less dollars floating around and people calling themselves wealthy because they can borrow wealth from those who have it. Ah, but that's getting off topic, sort of. Still, less lending means much less dollars in the economy, too. CDS pay outs also sap the money supply, as will heavier regulation.

This is the deflation we all fear, money disappearing into the same thin air whence it came. (Fake wealth, I guess...debt money...disappearing.) Who is gonna fund China's economy? Russia? (hehe)

And why is China worried about the dollar? Unless we recover quickly and get right back to business as usual, the dollar will be just fine.

With regulation and the heavy debt burden felt by many Americans, a recovery should not be "L" shaped...more like a square root symbol, as one contributor put it. In any case, I read and believe demand will remain low for many decades.

Oh, and the scale of this crisis, the sheer mass of money lost, dwarfs anything I am aware of. It's so huge, so scary, it just cannot be over just yet. A recovery this quarter is too easy. We're talking a ton of money here. I'm prepared for round two, especially with banks still announcing write downs, credit tight, unemployment still bad...better, but very bad, federal health care, and ballooning federal debt.

How does a world economy adjust to losing $20 trillion in liquidity? Answer, it can't, not in the short term...not so quickly. Well, not unless Joe Six Pack doles out more of his tax dollars...thanks, Joe!

Aug 12 06:29 AM

[Brett Owens:]

Well said Asbytec!

Good new video over on Yahoo Tech Ticker - Bob Prechter shares his deflationary depression hypothesis for the mainstream: finance.yahoo.com/tech...-"Deflationary-Depress...

Aug 12 07:36 PM

[Asbytec:]

Brett, thank you for the link. You have hit on a topic that is not well covered in many forums and certainly not in the news. In my opinion, the cause of deflation IS the big picture issue. I thank you for giving it exposure.

Aug 12 08:40 PM

[Asbytec:]

I haven't argued this point in a while and I was remiss is discussing the Yen carry trade, which is (was) a significant portion (on the order of 20%) of global liquidity. I haven't looked in a while, but I suspect conditions are stable enough for the carry trade to pick up a bit.

Aug 12 11:04 PM

[Asbytec:]

One last comment, Bernie Lo is interviewing Kirby Daley on Bloomberg, as we speak, and is discussing this very subject. He agrees it ain't over.

Aug 12 11:24 PM

[Asbytec:]

On Aug 10 02:37 PM Prudent Man CFA wrote:

> The dollar, to be of value, is to be backed by value. Where is the
> beef? Geithner's signature on the newly printed currency?

Prudent, been thinking about your comment, it's an interesting and controversial topic raised many times in this forum. Yes, all currency should be backed by value, say gold or production. I'd agree with that and eliminating the Federal Reserve and fractional banking system. But until that happens...

For those who bash the dollar, specifically, then I ask this question. What backs the pound or the euro? It seems a tiny bit of good news about EU growth spurs a rally in the sterling and the euro. But, the dollar rallies during bad news. The US should be the first to pull out of this recession and should break the dollar's correlation with a flight to safety status. But why are the pound and euro rallying?

Of course, part of the answer is interest rates. A flight to risk makes them attractive over the dollar. Still, this doesn't mean they are backed by anything more meaningful than the dollar. They are fiat currencies, too, as you know. At least the dollar has the lion's share of reserve currency status. That ought to mean a little something.

The case is especially interesting for the pound sterling. Britain doesn't have much industry to speak of, a failed auto and airline industry and what else? They are primarily getting rich from financial instruments, more so than the US. So why, especially, the interest (pun intended) in the pound? It's backed by the same promise to pay as is every other currency.

In any case, I've made the argument in other venues if the dollar falls, all fiat currencies are doomed. The question is, which one will be laying on top of the heap? In such a scenario, I bet even China could not print Yuan fast enough to supply Wally Mart with low cost goods. Oil will climb to, or over, $200 and will probably stunt the global economy. US imports will drop off dramatically, even as other nations inflate to keep up. In any case, it won't be a pretty picture...anywhere.

" 'All fiat currencies fail,' and all currencies are fiat..." (quote me) :-)

Aug 13 11:14 PM

[Michael Clark:]

My charts don't show a dollar bottom. The dollar has been gaining momentum recently. I'm expecting to see a bottom and a rally -- just don't see it yet.

Aug 31 06:15 AM