Currencies represent the largest, most liquid market on Earth and the ubiquitous US dollar (UUP) is the most widely traded and transacted. It truly is the world's currency. Our trading partners have long believed we're the richest and most powerful country in the world (always will be) and would never debase our currency.
Unfortunately, in 1971, Richard Nixon did just that when he severed the dollar's connection to gold, hacking into the ropes that held the mighty dollar blimp to the ground and unleashing it on the sky. While the implications here are complicated and debatable by economists far and wide, suffice to say the fate of the dollar is no longer ours to determine. The President, the Treasury Secretary, not even the mighty Ben Bernanke can say what happens from here. The dollar is on its own.
When I started trading currencies in 2007, I was a full-on dollar bear. Beyond the reasons stated above, anyone with a rudimentary understanding of technical analysis could look at a chart and see that the buck was in terminal decline. Oh, how much I had to learn! 2008 was a trial-by-fire for traders of all stripes. From novice to experienced, forex to equities, the opportunities for growth and insight were everywhere and so were the risks. In fact, my first trading account was blown to smithereens thanks to an over use of leverage and lack of a disciplined trading plan (a common outcome for those crazy enough to take on currencies). Still, the most important thing the crisis taught me is this - fundamentals are always subordinate to money flows. Let me explain.
The fundamentals of the US economy are terrible. Some will argue this isn't true, but from demographic trends to trade imbalances, get real. The same is true in Japan. Yet the dollar and even more so, the yen, turned out to be the strongest currencies in 2008, crushing the currencies of their stable and more prosperous neighbors like Canada and Australia. Why is that? The media refers to them as "safe havens" even though they're anything but. It all comes down to money flows. In what I see as the greatest irony of the fiat money era, the enormous supply of dollars and yen makes them incredibly popular when nervous investors dash out of stocks and into cash. Totally defying the Economics 101 law of supply and demand, their instant availability actually increases demand during times of stress. Does that make them safe havens? No. It means they're easy. Please, no risqué jokes here.
Trust me, this dynamic keeps Ben Bernanke up at night. Though he claims the currency is the responsibility of the Treasury department, he's the one with his finger on the trigger of the printing press. In a perfect world where he actually had the kind of control he thinks he has, some combination of interest rates, jaw boning and covert ops would allow him to keep the dollar right where he wanted it, not too hot and not too cold, just like delusional Larry Kudlow's goldilocks economy. But that blimp set sail a long time ago with the closing of the gold window. The dollar's gone rogue.
I expect this conundrum will come to define the rest of Bernanke's term. He understands that a weak dollar, while snuffing out middle class savers, also lowers the value of the country's debt and supports asset prices for his buddies at too-big-to-fail institutions (make no mistake, this is where his true allegiance lies). Amateurish attempts at communication and perception management were on full display at the Fed's first meeting of the year where the chairman's voice cracked and nearly broke as the illusion of control slipped away in a jumble of wonky econo-speak. What he really wanted to do is shout, "Look at me, I'm a dove! I got QE3 in my front pocket and 4, 5, and 6 in my back."
Ben Bernanke doesn't know it yet, but all his attempts to massage the greenback lower will fail. Until they don't.
The Tipping Point
My thesis is this - Bernanke will get his wish but not on his terms. Who knows, it might even come with a new Chairman in the catbird seat. The fact is, the credibility of the world's reserve currency has been undermined. The dollar has been moving higher for several weeks now but its ascent shouldn't be mistaken for a sign of strength. Without getting into a lengthy discussion on how complex systems break down, it happens suddenly. A tiny fracture becomes an ominous hole. I'm afraid Ben Bernanke doesn't understand. I'm afraid it's too late.
In a follow-up article, I'll take at the investment implications of a dollar collapse.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.