A Ticking Time Bomb For The U.S. Dollar In Yesterday's Budget/Debt Limit Agreement

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 |  Includes: CNY, FXA, FXB, FXC, FXE, FXY, UDN, UDNT
by: Dave Kranzler

Does everyone think yesterday's predictable ending to DC's version of a Mel Brooks comedy was a good thing for our system? Consider this: embedded in the legislation just passed and imminently to be signed by Obama is this sub-section: "Default Prevention Act of 2013." This particular provision, buried deep in the "Continuing Appropriations Act of 2014" (the Government is currently in its 2014 Fiscal Year), enables the President to waive any legislation in February that attempts to block the next raising of the debt ceiling limit. Ultimately, this will prove to be lethal for the U.S. dollar and interest rates.

You can wade through the opaque legalese if you wish here: Budget/Debt Limit Bill (scroll down to page 24 of the pdf for the relevant section). Or you can read my summary of the provision here:

Up until yesterday, Congress had to approve of any increase in the debt ceiling. Theoretically it gave Congress leverage to negotiate with the President before approving of an inevitable debt ceiling increase. Now, if Congress refuses to pass a debt ceiling increase, the President has the power to veto the rejection. In order for Congress to override the President's veto, 2/3's of both Houses of Congress would have to approve of the rejection of the President's veto. There's no way both the Senate and the House would be capable of doing this. In other words, the President now has the ability to unilaterally get rid of the debt-ceiling limit. QE to infinity.

Everyone follow that? In effect, and for all practical intents and purposes, although in theory it's not entirely the case, the U.S. Government no longer has a debt ceiling limit. It was only a matter of time before everything came to this. And now it will require a lot more Federal Reserve money printing in order to fund the enormous issuance of Treasury debt that is coming our way. There's no way the Chinese and our other big foreign financiers will ever agree to invest money in the bonds of a country that has absolutely no constraints on debt issuance.

This is why the U.S. dollar has been literally falling off of a cliff since early July. It's why the euro is now seen as a more stable currency than the dollar. None of the individual countries in the EU has the ability to borrow, print and spend limitlessly as does the U.S. now. Tenuous as they may be, there are checks and balances in place in the EU system that no longer are in the U.S.

The U.S. dollar can be looked at as the "stock price" for the U.S. Government, since it's the full faith and credit of the U.S. Government that stands behind the value of the dollar. Here's what happened to the "stock price" of the U.S. Government yesterday:

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As you can see, as soon as it became apparent to the market that Congress would give in to the White House, the dollar jumped off a cliff (left side of the chart). Then, after Asia's markets closed for the night, China's official debt rating agency (Dagong) - don't forget, China is the biggest buyer of U.S. Treasury bonds - issued a downgrade of the U.S. Government's credit rating from A to A-. This is a mere four notches from being considered junk bond status. The dollar was sold off hard.

Here's a longer-term view of the U.S. dollar:

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As you can see, the dollar has dropped by a considerable amount since early July. The bounce you see in June was artificial intervention designed to make the market think that Bernanke was serious about tapering and that the U.S. still had a strong dollar policy in place. The rapid decline since early July is the rest of the world coming to understand that there's no way the Fed can possibly stop printing money and buying Treasury bonds without causing a collapse in the system.

We saw that dynamic in effect in September when the Fed defied everyone's (except mine) expectations and deferred on tapering; we saw that dynamic in effect during this latest budget/debt limit battle between Congress and the White House; and now Fed officials are coming out and saying that tapering is not possible for the time being: Fed's Evans Says Still Too Soon To Taper.

As I write this, the U.S. dollar index is down 1.4% from yesterday's morning high. A 1.4% move in a day in currency markets is considered a huge move. The dollar is sitting on tenuous support in the upper 79 area, it set a new low since July's sell-off started and technically it could sell off pretty quickly into the mid-70s if it starts to look like the U.S. economy is headed into contraction, which I believe it is.

As such, I think it is possible to trade every dollar bounce up by shorting the U.S. dollar. As my chart above shows, the momentum indicators are signaling that the market is indeed selling the dollar into every rally. While I defer you to the FX-trading experts on Seeking Alpha for specific trading vehicles for speculating on a bigger decline in the U.S. dollar, Powershares DB has both a short U.S. dollar ETF (NYSEARCA:UDN) and a 3x short U.S. dollar ETF (NYSEARCA:UDNT). You can also short the dollar against specific currencies using CurrencyShares ETFs: euro (NYSEARCA:FXE), yen (NYSEARCA:FXY), Canadian dollar (NYSEARCA:FXC), British pound (NYSEARCA:FXB) and the Ausralian and New Zealand dollar (NYSEARCA:FXA). Also, you can short the dollar against the Chinese renminbi (yuan) using MarketVectors renminbi/dollar ETF (NYSEARCA:CNY).

While I expect the dollar to exhibit some volatility going forward, going forward, based on my analysis, I think shorting the U.S. dollar on every bounce is a great way to hedge your wealth against the dollar-debasing, deficit spending behavior of the U.S. Government.

Disclosure: I am long CNY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.