Divining the Next Crisis: All Eyes on the Dollar 19 comments
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As I wrote earlier this year, the US’s monetary policy has already sown the seeds of the next Crisis. It is now no longer a question whether or not another Crisis is coming; instead, it’s a question of which Crisis and when. I’ve detailed what I think are the three general options below:
Quite a few people wrote me last week telling me I was insane for even claiming that the US Dollar could rally. But, in reality, this is the outcome Americans should all be praying for given the alternatives. A Dollar rally would only damage stocks and commodities, whereas a Currency Crisis would effectively destroy the economy and a Country crisis… well, that one is obvious.
Stocks generally get all the attention from the media. But, in reality, they are relatively small fry compared to the Bond and Currency markets. As of 2008, the world stock market was roughly $36 trillion in size. In contrast, bonds were $67 trillion and forex (currency) which turns over $3.2 trillion per day -- ten times the daily volume of every stock market in the world.
Suffice it to say, a Crisis in stocks would be the lesser of three Crises. And those of us in the US should be hoping it’s the Crisis we get as opposed to a Crisis for US debt or the Dollar.
The good news is that it seems this is what we’re heading for. In the last two weeks, the US Dollar broke its downtrend:
And stocks broke their uptrend:
I also want to point out that the Wilshire Index (the index containing every publicly traded US company) broke below its uptrend as opposed to the downtrend set by the beginning of this bear market (2007-present):
Looking at these, it seems that Crisis #1 (stocks collapse and the Dollar/ Treasuries) rally is the most likely candidate for the upcoming Crisis. However, to be sure of this, we need to see long-term Treasuries hold their 20+ year uptrend.
As I’ve written before, the Federal Reserve accounted for nearly half (49%) of all Treasury purchases in the second quarter. During the same time period, foreign investors (China, Japan etc.) decreased their purchases of US debt by 40%.
In simple terms, foreign investors are not interested in buying US Treasuries at current yields (with the 30-year yielding 4.4% and the Dollar losing 15% in value this year alone, I can’t say I blame them).
Now, to get higher yields you need bond prices to fall. The Fed’s Quantitative Easing program (in which the Fed bought Treasuries to artificially create demand) just ended… so we’re about to find out what the bond market thinks of US debt without life support. If demand is so low that Treasuries break their 20-plus year trend-line, then look out, we may be heading for Crisis #2 or Crisis #3.
Looking at a close-up of the 30-year’s chart, it looks like we’ll know the deal (whether bonds will collapse along with stocks) sooner rather than later.
In conclusion, my main point is this: It’s now certain that a Crisis is coming… it’s now just a question of which one and when. So far it looks like it will be a Stock Crisis (a replay of last year in which the Dollar rallies and commodities and stocks fall). However, don't get too caught up watching stocks right now. The bond market is larger and much more significant in terms of forecasting what’s to come. And with the Fed’s artificial support for Treasuries just ended, we may be about to find out.
Keep your eyes on the long end of the Treasury market and the Dollar. They (not stocks) will be dictating what’s to come.
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This article has 19 comments:
Another reason I believe inflation is in the cards is that it is one of the few things that allows the treasury to deal with all those devalued mortgage backed securities they bought up. Inflation == increasing home prices. Even though in a normal world it also means decreasing loan value due to the lower interest rates on the long-term MBSs an improvement in home prices will trump that.
So the treasury is going to steer us towards moderate inflation to get out of this mess. When it happens remember this posting and don't blame the current government for it, there really isn't much else they can do. The time to deal with the crisis was 5+ years ago, before it became a crisis.
I'm not sure what is going to happen to the dollar but inflation will mitigate any strengthening. That is, we could see significant strengthening offset by significant inflation and wind up with big fat net-zero from the point of view of the rest of the world.
-Matt
A cultural crisis leads to a Constitutional crisis, which in turn means that personal and property rights erode, decay and crumble : all within clear view of the citizens. As basic rights crumble the rule of malign men and women----- to whom people are mere masses , their lives mere statistics and their labor and possessions easily and mercilessly expropriated------repl... the rule of law.
When this occurs and indeed is occurring, vapor scrip replaces real money, irreedamable debt replaces wealth and crises cascade and multiply but The Regime little cares because it believes itself to be invulnerable; indeed, beyond the laws of morality and justice.
The various crises listed in the essay are manifestations of the root crisis: they are not sequential but overlapping. Since nothing matters to The Regime except the satisfaction of its insatiable appetites for wealth, power, and fame it will consume all it can lay waste: the dollar, the Constitution, the Middle class, national wealth , income ,honor and security.....And then civil society itself.
The crises will continue until either The Regime is faced, purged and expelled or America ceases to be.
The US Regime or America: it is to that defining decision where all the crises are converging. Being or non-Being?
Reality or Unreality? the outcome is, at present, unknowable.
The inverse relationship between the dollar and stocks is a fairly recent one, since about '03. Transitional can last years and markets are reflecting the cumulative irrationality of our policies, not bedrock principles of true wealth-building.
At least a dollar rally puts some benefits of this rumored "deflation" into average American's budgets rather than just into their paychecks.
certainly letting the market drop is much more a big deal for the 1% that own 98% of the stocks -
for the regular guy, a currency that holds its store of value would be much more beneficial -
is there anyone still representing us regular guys?
A good point. A trader could get whipsawed. Be flexible and set stops.
Not to be facetious, though it is my "style", but is there any evidence that the Fed could placate Treasury demand through "backchannels" (having 3rd party purchase Treasury bonds during sale only to have, a week or two later, the bills sold back to the Fed in order to provide the initial "demand" during initial bidding...) now that the Fed has stopped buying...? Perhaps I'm just grasping at straws................and more straws...and more....OR..perhaps I've had too much to drink....
Cheers!
This is a very simple model, admittedly, but it seems plausible and we can watch the Treasury auctions for the upcoming week that are published beforehand on the TreasuryDirect.com web site. This asset price "push" acts like a linear term in an equation for broad market index prices. Against its effect is the resistance of fundamental value whose lack of change leads to a dwindling number of sellers (new sellers only coming with higher prices). But to this simple system adds the unstable terms that are both unpredictable in their timing and magnitude. In addition, should fundamentals be recognized as sour, new sellers will appear and prices drop. Nevertheless, until market players get wise (?) or panicked I look for decreasing waves of upward price movements, assuming the Fed keeps pumping in the money.
Any of the above-described crises should be sufficient to inform the public that housing prices are not rebounding any time soon. Thus, I also foresee a moral hazard crisis in residential real estate, as people (especially those in non-recourse states) figure out that there's no reason to keep paying a mortgage that is obviously a dog. Right now it's only the moral obligation to pay debt, combined with apprehension about ruining a credit score, that keeps many people paying mortgages. Both of those factors should get blown away in the next crisis.
strutzma
I was thinking along those lines, ie, why would the Fed stop sucking up Treasury bonds if they know the non-Fed demand just isn't going to be there? They aren't going to pull the plug on these bonds when they are one of the largest holders!
Possible answer: because they need to prop up demand while being seen as "not" buying anymore.
Maybe they have in place a substitute "source" of demand to basically launder the bonds that they are buying?
1. The USD still performs most of the global functions as the major reserve currency and no other currency it positioned to take its place in that necessary role.
2. The other major economies and their currencies have significant problems that, while not necessarily as sever as those of the US and its dollar in every detail, off-set some of the US negatives to which you refer (or limit the near term capacity of these other economies and currencies to gain in relation to the US and USD)
3. It is very much in the interest of all major nations that the US not suffer the crises you describe and they are keenly aware of this.
The upshot if these points hold true is that, provided that the major economies continue to coordinate their economic initiatives, the second and third level of crisis you describe are highly unlikely in the foreseeable future and a setback along the lines of your first level, even if it were to occur, would be much milder in nature and extent than you project.
On Nov 09 02:26 PM adan wrote:
> great article, thanks!
>
> certainly letting the market drop is much more a big deal for the
> 1% that own 98% of the stocks -
>
> for the regular guy, a currency that holds its store of value would
> be much more beneficial -
>
> is there anyone still representing us regular guys?
The dollar has since resumed its downtrend and is back "in the channel". Equities have resumed their uptrend.
A friend of mine dined with a giant in NYC real estate (not Trump) and he sees the next shoe dropping soon. Inflation? From where?
On Nov 09 12:20 PM MattZN wrote:
> I like the analysis though I don't agree with your 'most likely'
> scenario. I think the government is clearly putting a priority on
> jobs even if that means running up the debt. With the easing coming
> to an end the result has to be inflation. Even though Bernanke isn't
> saying it I'm guessing that he is expecting inflation too and is
> trying to figure out how best to limit its scope. If the government
> can keep inflation under 7% then we win (or, at least, we do not
> lose). Over 7% and it turns into another crisis.
>
> Another reason I believe inflation is in the cards is that it is
> one of the few things that allows the treasury to deal with all those
> devalued mortgage backed securities they bought up. Inflation ==
> increasing home prices. Even though in a normal world it also means
> decreasing loan value due to the lower interest rates on the long-term
> MBSs an improvement in home prices will trump that.
>
> So the treasury is going to steer us towards moderate inflation to
> get out of this mess. When it happens remember this posting and
> don't blame the current government for it, there really isn't much
> else they can do. The time to deal with the crisis was 5+ years
> ago, before it became a crisis.
>
> I'm not sure what is going to happen to the dollar but inflation
> will mitigate any strengthening. That is, we could see significant
> strengthening offset by significant inflation and wind up with big
> fat net-zero from the point of view of the rest of the world.
>
> -Matt