The Dollar Challenges Equity Markets and Theories

by: Carlos X. Alexandre

It has been said frequently that the U.S. dollar is on its way down, if not out. I respectfully disagree, and dont say it as a matter of patriotism, but rather practicality. The euro was introduced to become a serious contender as a reserve currency, among other reasons, but never truly captured the imagination of the international markets, implying that investors have always distrusted the concept.

Since the beginning of the year, investors looking for asafecurrency have been driving the Swiss franc higher. Since June of 2010 the franc increased 37% in relation to the dollar, from around $0.86 to $1.18. During the same period, the franc increased 14% against the euro. The reasoning may have been thatand we would have to ask everyone involvedthe dollar was no longer the currency of choice for a variety of reasonsbe it economics, politics, or anything in between. But that is changing.

And I know that the debate is always whether the dollar strength is really a result of euro weakness -- and vice-versa. Does it matter?

Some opinions refer to the eventual demise of the euro, the reintroduction of the Deutsche mark, Greek drachma, and so on. But the process, if it ever takes place, will be chaotic at best, and Europe must contend with a run on banks, especially if depositors get a hint that their accounts are being converted, for example, into Portuguese escudos. Furthermore, Germany will lose the pricing advantage when having to do business with neighbors with extremely devalued currencies, not to mention the shattered dream of a united Europe.

Even if a currency swap was planned in secret -- and leaks always occur -- how would businesses modify their prices and accounting systems the morning after? How would the common citizen exchange their euros for drachmas or escudos? It's a logistical nightmare.

At times one must dig deep to uncover the overlooked nuggets. Other times, one has to sit back, miss the trees for the forest, and simplify the thought process. Over the last four years, in the midst of one of the worst economic crises that we have witnessed, the dollar has endured despite its ups and downs, and the opportunity to establish an alternative reserve currency by the international marketsnot politicians or bureaucratshas not come to fruition. Aside from the euro, China could have stepped up to the plate to at least grab market share. But they arent interested in floating the yuan for obvious reasons.

Ill go out on a limb and state that in due time, well look back to June 2011 and see the third and final bottom for the dollar in so many years. Meanwhile, equity markets will have to adjust to the new reality and capital flows are already in adjustment modeand a lot sooner than what I anticipated.

The financials, as measured by the KBW Bank Index (KBE), have been dropping since February 2011, and even Apple (AAPL) has followed the same path during the same period.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.