Even the Fed Doesn't Want to Hold U.S. Dollars

This is the scariest image in finance:

The above chart shows the dollar’s performance since the Fed announced its Quantitative Easing program in March. This chart tells us two things:

1. Americans just got 15% poorer on the world stage thanks to Ben Bernanke
2. A currency crisis is in the works (and perhaps already starting)

Regarding #1: When the financial crisis hit, the Fed realized it would need to keep interest rates low while it attempted to bail out the banks (80% of the $200+ trillion in derivatives sitting on commercial banks’ balance sheets are related to interest rates).

The problem with this is that it makes Treasuries very unattractive to foreign investors (China & Japan) who want a higher yield. Consequently, the Fed decided to pick up the slack by buying $300 billion worth of Treasuries through the now famous Quantitative Easing program.

As I noted last week, the Fed is now the largest buyer of US debt (it bought more debt than the next three largest buyers combined in 2Q09). China and Japan are no one’s fools. And they’re not going to fund a monetary policy that is both profligate and likely to erode the value of their dollar holdings.

Which brings us to item #2: the coming dollar crisis.

I am not a huge fan of technical analysis, but it is a useful tool for navigating a trader-heavy, liquidity driven, manipulated market such as today’s. On that note, I want to point out that the dollar began forming a falling bullish wedge pattern starting in June (see above chart). This pattern entails an ever-tightening range of lower highs and lower lows and typically precedes major breakouts to the upside.

Except it didn’t.

As you can see, the dollar broke down out of this pattern in late September. It then rallied back up into the trading range before breaking down again. This is bad news. The next line of support (place where the dollar could bounce) is 76. We've already broken that one too.

Now the next line of support is 72. Now, the dollar has only fallen to this level once in the last 30 years (Summer 2008, see the chart below). If we fall below that, then we’re in uncharted territory and a major dollar devaluation is in the works.

Perhaps it’s already happening.

To review a point made earlier, the dollar has lost 15% of its value since March 2009. On an annualized basis, we’re talking about the dollar losing almost a third of its value in one year (30%). That is an absurd level of devaluation. And China, Japan, etc. have had enough. It is now clear that a flight from the dollar has begun; the Fed buys more US debt than the next three biggest buyers combined.

However, what most people don’t realize is that even the Fed itself is shifting away from the dollar. Everyone knows that China and Japan hold massive foreign reserves (the dollar). But the US Federal Reserve does this too (we own euros, yen, etc.). And for some reason the amount of foreign reserve assets (non-dollar assets) on the Fed’s balance sheet skyrocketed by 50% to $133 billion at the end of August.

Now, $133 billion in foreign reserves is nothing compared to China and Japan’s ~$3 trillion. But a 50% increase in one week is an astounding rate of change.

The culprit?

A 500% increase in SDRs: the “global” currency issued by the IMF. The blog ZeroHedge caught this story first and pointed out that SDRs are the IMF’s means of maintaining a “super reserve” currency for the world. SDRs are defined as: a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar.

Now, one has to wonder why the US Federal Reserve decided to suddenly buy $40 billion worth of SDRs overnight. The answer is that the IMF decided to massively increase the amount of SDRs outstanding from SDR 21 billion to SDR 204 billion in late August.

This came as part of a G20 decision made in April 2009 to stabilize the global financial system. Interestingly, of the countries involved in buying SDRs, the US bought the most at SDR 30 billion, compared to Japan (SDR 11 billion), and China (SDR 6 billion).

I realize this is getting a bit technical. But in simple terms this means that the US Fed intentionally participated in a world reserve currency scheme that devalued the dollar.

Folks, even the Fed doesn't want to own dollars. It’s time to look for a currency that can't be devalued.

Comments

[TeresaE:]

Deflation of wages and assets while the simultaneous decrease in buying power for our necessities.

What a beautiful thing our policies are creating.

Too bad we can't wake up the sheep that could help avert disaster, for now they are sitting on overvalued stocks and government intervention dollars.

In short, the upper middle/lower upper classes just don't care. Today.

When this hits them, and it will, then they will care but I fear it will be too late.

Oct 23 11:14 AM

[Shocksink:]

This is really scary. Millions and millions of Americans will starve.

Oct 23 11:55 AM

[Mad Hedge F...:]

ppx It’s all about the dollar, which I have despised all year (click here for my call ) like the red headed stepchild it has become. The assured onslaught of federal debt issuance headed our way will be the overriding investment consideration for traders and portfolio managers for the next decade. That will knock the stuffing out of the greenback against every currency except the Zimbabwean dollar, and even that will rally when you get a long overdue regime change. As the new currencies of barrels of crude oil, 100 pound ingots of copper, or rail cars of iron ore won’t fit into your wallets or purses, foreign currencies offer a great dollar alternative. There was once an argument that foreigners piled into these currencies to capture a huge yield pickup, but even that advantage is now gone, with almost everything now yielding nothing. The soggy buck also explains a lot of what is going on in our stock market, with companies earning most of their revenues from increasingly wealthy foreigners, like those in technology, energy, and commodities. As I write this, I am looking at new one year highs for my favorite picks of the former British crown colony currencies of the Canadian dollar (FXC), up 28% YTD, Australian dollars (FXA) up 49% , and New Zealand dollars (BNZ), up 80% dollars (for my C$ report click here ). Their bounteous resources, Anglo-Saxon contract law, a semi common language, and vibrant ports make them the safe bet of choice. Sure, they are all overheated and way overdue for a short term pull back. But over the long haul, you can count on the loony to hit parity, to be eagerly followed by the Aussie dollar, and then the kiwi. And once again, I am including a gratuitous photo of my favorite Canadian, Pamela Anderson.

Oct 23 11:56 AM

[doubleguns:]

" It’s time to look for a currency that can't be devalued."

Very simple, got gold?

Oct 23 12:05 PM

[athena:]

I wonder-- is the fear of imploding swap positions now steering the Fed's policy?

Oct 23 12:41 PM

[user396040:]

In evaluating the "scariest image" chart, one should bear in mind that in March, 2009, the dollar was at a riduculous and unsustainable high created by a world wide panic and flight to dollar liquidity. The chart looks very different if you move back the start date to 2007 or early 2008. I think that in the last 6 months we have returned to a more normal valuation of the dollar.

Oct 23 12:44 PM

[Robert Mart...:]

Graham:
The dollar's decline is so ominous, and the forces behind are so massive and obvious, that I have to wonder why it isn't THE story on Wall Street and in Washington.

The best explanation I can come up with is that short-term factors are distorting inflation expectations. Two temporary factors stand out:
1) Energy prices have been declining on a year-over-year basis, reducing reported inflation. Unfortunately, global reflation is takes root, and rising demand will push oil prices back above $100.
2) Quant easing has depressed yields on both Treasurys and TIPs. So "implied inflation" is a sham.The U.S. "solved" the credit bubble with easy monetary and fiscal policy, and destroyed the dollar in the process.

Alternatively, maybe people realize what is happening. Maybe people are just burying their heads in the sand.

In any case, thanks for the article!
Rob

Oct 23 02:10 PM

[Ricard:]

Oh what a tangled web we weave...
When first we practice to deceive...

Oct 23 10:37 PM

[Tom Szabo:]

This article is silly. Nobody chose their SDR allocations, they were made in accordance to each country's IMF quota, which represents that country's contribution to total global output as measured by the IMF. With such a faulty premise, the whole article is junk.

Oct 24 04:16 AM

[user369285:]

In that case, OmniSans owes the readers a response to this statement.


On Oct 24 04:16 AM Tom Szabo wrote:

> This article is silly. Nobody chose their SDR allocations, they were
> made in accordance to each country's IMF quota, which represents
> that country's contribution to total global output as measured by
> the IMF. With such a faulty premise, the whole article is junk.

Oct 24 09:17 AM

[bilejones:]

What ludicrous doomsaying,

The P/E on the S&P500 has decreased from 144.81 two weeks ago to only 143.75 this last week. Things are definitely looking up.

Murdoch's Barron's has the index P/E's here:
online.barrons.com/pub...

Oct 24 05:03 PM

[dimitrius:]

This is dumb. They bought SDR's for stability's sake. Not because there is a conspiracy to dump the dollar. For every argument about the USD, there is an equally valid counter argument. Get a life.

Oct 25 02:23 AM

[realold:]

"Wouldn't it be nice if someone in government actually explained what they think they are doing on a regular basis? This may be beyond their capacity, but it might also cut down on the dollar/gold/china/obama conspiracy theories. At worst, it might at least verify them. As is likely with Obama.

Oct 25 05:26 PM