Saving the U.S Dollar: Wall Street's Next Big Bailout?

Ask yourself a simple question: Do you believe that the U.S. dollar will appreciate over the next decade?

If you answered "Yes" you should be buying stocks. If you answered "No" you should be getting ready for a painful bear market. The argument here is simple, and is based on four assumptions:

Assumption 1: Share prices are more likely to rise when increasing volumes of money chase the same number of shares. If, on the other hands, lower volumes of money chase the same number of shares, prices fall. This is why the Zimbabwe Stock Exchange was the “best performing” stock market in 2007, with the benchmark index gaining 595% in 10 months as the government dramatically increased money supply.

Assumption 2: American investors can't provide the necessary funds to fuel a stock market rebound. Everyone knows about America's (negative?) savings rate, so it seems unlikely that American savings will push the stock market higher (as explained in Assumption 1). Some Americans used home equity to fund expenses, and this can't go on now that U.S. home values are collapsing. Factor in higher oil prices and a weakening jobs market, and you soon realize that there is less new money available for investment.

Assumption 3: If we assume that U.S. investors don't have sufficient funds for investment, it means that a U.S. stock market rebound will only be sustainable if foreigners are buying.

Assumption 4: Foreigners will refuse to buy U.S. stocks if the U.S. dollar continues to slide lower. It doesn't take a rocket scientist to figure out that a foreigner's investment in a U.S. stock can be wiped out by a depreciating U.S. dollar. As an example, if a Japanese investor invests in a U.S. stock that gains 5% while the dollar depreciates by 10%, he loses 5% of his initial investment. On the other hand, foreign investors will rush to buy U.S. stocks if the U.S. dollar comes back from the dead.

I admit that my analysis here is overly simplistic, and I agree that the greenback is only one of many factors that affect U.S. stock market movements. The point I am trying to make is that a meaningful U.S. stock market rebound is less likely to occur if the greenback continues to weaken. Considering that the trigger happy Federal Reserve is slashing interest rates and quickly running out of ammunition, only coordinated central bank intervention can save the U.S. dollar.

"History shows that, as a rule rather than an exception, multilateral coordinated interventions have been key in establishing turning points in multi-year trends in the major currencies in the past three decades," says Stephen Jen at Morgan Stanley, in a note published on March 17. "The preconditions for coordinated interventions are not yet met. However, given that a weakening dollar is fueling dangerous vicious circles through commodity prices and eroding confidence, it is prudent to remain on an intervention watch, monitoring closely whether the preconditions for interventions are met."

Perhaps Wall Street's ultimate bailout will come when central banks coordinate efforts to save the U.S. dollar...

Comments

[Metzenbaum ...:]

Simplistic analysis = looks a lot like mine. I am reminded about how long the markets can remain irrational... (and I bought BSC yesterday afternoon)

2008 Mar 18 10:51 AM

[sedek:]

Interesting points, but I don't see centrals intervening in any manner other than continuing to devalue their own currencies by printing more money. The idea of Japan, China, and the oil producers buying more Dollars as their massive holdings are falling is short term, will be no better than a temporary slowdown, and will cost them more in the long run.

The only intervention that can stop the Dollar from falling further now is for the FOMC to accept that increased liquidity does not create increased counterparty trust and to not cut rates further this meeting. As a 75 bp to 100 bp cut is already priced in to the Dollar and commodities, a cut refusal would cause an immediate and major rebound in the Dollar and should take oil to $100.

2008 Mar 18 01:29 PM

[LIFELINE INT:]

THE POLICY OF THE US HAS BEEN TO DELIBERATELY
LOWER THE VALUE OF THE US$, HOWEVER WILL
THIS PLOY WORK AGAIN? ONCE THE MIDDLE EASTERNS
GET SMART AND ADOPT A MIDDLE EASTERN LETS
SAY FOR ARGUMENTATIVE SAKE MIDDLE EASTERN DOLLART
AMD DEMAND THE EXHCHANGE BE DONE BEFORE PURCHASING OIL, LETS SEE IF THEY GET AWAY WITH
THIS.
EVERYONE KNOWS THE USA DOES NOT HAVE A
COMPREHENSIVE ECONOMIC POLICY. IT IS MANIPULATED
BY THE POLITICIANS WITH THEIR VESTED INTEREST
GROUPS, WHICH ORIGINATES FROM THE POLITICAL
CONTRIBUTION SYSTEM. THERE IS NO ENERGY POLICY
EITHER TO REDUCE THE DEPENDENCE OF FOREIGN
OIL WHICH SHOULD BE STRATEGIC PRIORITY NUMBER
ONE, JUST HOW MUCH MONEY WAS POURED INTO
THE LAST 2 WARS BY BUSH, IT IS A ABSOLUTE
CATASTROPHY, BUT WHAT THE HELL IT COSTS ABOUT
.10 TO PRINT A $100 BILL, SO IT DOESNT MAKE
ANY DIFFERENCE IN THE END DOES IT?

2008 Mar 23 10:06 AM