Has the Dollar Bottomed?

After the speculative devastation his policies have wrought on the US economy, perhaps the devalued Greenback should be renamed the 'Greenspan' in honor of  one of the worst central bankers this side of Zimbabwe. However, everything has its price. To paraphrase Keynes, in the beauty parade that is investment, the alternatives look even uglier.

The Euro, Yen and Sterling all risk major fundamental downside over coming months as evidence mounts that their respective economies are sliding into recession; decoupling is dead. Meanwhile the US trade deficit is in rapid decline (although the fiscal deficit is set to soar, perhaps to $1 trillion within a couple of years).

I turned more positive on the dollar in April, when bearish sentiment was extreme, in 'The Fed goes bust, the dollar goes up...', noting that the dollar had reached an inflection point in previous cycles midway through a recessionary period.

Since then, as the chart shows, the dollar index has traded sideways, which is technically a healthy sign after the prolonged slide since 2005, and particularly in the context of soaring crude prices, a big dollar negative, and relentless bad news on the US economy.

After this basing pattern, the prospects of a sharp dollar rally in the next few months are high if as I suspect, the housing market stabilizes and commodity prices slump. The risks of a US rate hike now outweigh those of a further cut. Moreover, the chances of intervention in support of recent official jawboning of the dollar are significant. The Fed and Treasury now see a stronger dollar as strategically important in battling inflation and the credit crunch fallout.

I take the view that this is just a cyclical economic downturn rather than Armageddon, albeit an unusual one in originating on the supply side via the credit markets. The media and investors are seized by confirmatory bias when it comes to the US economy; every shred of bad news is trumpeted as proof supporting the recession thesis, while any positive evidence to the contrary is discounted (as we saw repeatedly last week).

We have seen a similar pattern in oil until recently, where mounting evidence of demand destruction was ignored and even the most minor supply disruptions were used as an excuse to hype the price ever higher. The truly remarkable feature of the US economy is its impressive resilience in the face of the simultaneous impact of both the credit crunch and energy crisis.

As with the markets, we are already probably closer to the end than the beginning of this slowdown and history suggests that the US will again show surprising regenerative powers both politically and economically, helped by a uniquely adaptable business culture and the best demographic profile of any developed nation. Right now, many blue chip US corporates are trading at fire sale prices to a foreign buyer, and I'd expect a spate of hostile deals like InBev/Anheuser in the next few months, particularly in banking, resources and technology.

The real issue going forward is inflation, rather than the lingering subprime mess. The purchasing power of currencies is under pressure just about everywhere. Inflation is being systematically underestimated in official statistics, making bonds the worst long term investment (see US Inflation: A Three Card Trick...). The ECB has been printing money at 22% per annum, despite Trichet's tough public stance on inflation, while in the US M3 money supply is growing at 20% annually, China is at 18%, India is at 20%, and Russia is at 45%. The world is awash in excess liquidity and this as much as the commodity spike is now feeding into inflation.

All this of course gets the goldbugs hyperventilating, but I'm not one of them; the world really has moved on since Bretton Woods and gold is suffering fundamental demand destruction at these prices as much as oil. In a world of paper currencies managed by very fallible central banks, the least ugly contestant will take the prize, and right now that looks like the dollar.

Comments

[bbzz24:]

hehe. your 'fundamental' analysis seemes really selective. the chinese already are reducing their purchases of U.S. gov't debt. now they want to invest in euro p/e funds (no more blackstones). the arabs are doing that for quite some time. doesn't this look like a predicate for slowed borrowing and higher interest rates as well due to slack demand? and doesnt this lead to slowing U.S. economy which would lead to further shrinking of the trade deficit.

to me it looks like you are just trying to spin the imminent delevering of the U.S. economy into 'fundamental strength'. and have you wondered why the government has to run 6% of GDP budget deficit and a SIV (aka war on terror in Iraq/Afghanistan) that accounts to another 3% of GDP, and another 1% on 'fiscal stimuli' to avoid the technical definition of recession: shrinking GDP. 10% real GDP deficit spending to inflate the economy with 1-2% 'growth'! i guess steroids are not banned in the congress either. for how long these 'fundamentals' can hold on?

2008 Jul 28 06:25 AM

[CLH:]

Good post Sean. I agree. The US will be first to come out of the credit crisis which means a strengthening of the dollar. Euro is grossly over priced. When Europe raised interest rates, it had no effect on the dollar.

2008 Jul 28 06:55 AM

[buyitcheap:]

Sounds like you're saying the dollar has a "nice personality" relative to other currencies, but yet fundamentally unattractive. :-)

Higher rates are indeed coming.

2008 Jul 28 07:45 AM

[Pauly B:]

I hope your right. My purchasing power hasn't been so resilient. A strong middle class is the key to strong growth. Right now the middle class is really taking a hit. I don't see anything improving with the lousy job numbers being posted each month.

I agree that it is only a matter of time before the Euro takes a hit and wont be so attractive.

2008 Jul 28 09:06 AM

[Kelly Liebe...:]

I think I will go scan some $100 bills today to pay for my family's bills this month... after all it doesn't affect anything in the short or long term as most of the analysts seem to reason... And while I am at it I will max out all my credit cards and just pay for it later with more "printed" money from my scanner...
Let's all do it... just like the Fed... they won't care... they created the trend and apparently have legalized it. Hooray!! A free for all!
Gold is being manipulated by the govt. to prop the dollar as long as possible... so that the people don't see what the true situation is. Hold on to paper at your own risk...or print your own, like the Fed and see how long you get away with it.

2008 Jul 28 09:13 AM

[NOWHEREMAN:]

3 or 4 months of sideways movement does not a bottom make. More importantly, oil prices dropped 15% plus and the dollar did not rally. This a major disconnect from the perceived notion that commodity spikes are dollar driven.

To have the dollar strenghten, the US economy must also. Since the US economy is 2/3rds consumer driven and the end of the Credit Crunch is nowhere to be seen, at best, the dollar will go sideways.

Personally, I expect to see the DXY break below 70 before any rebound.

If Israel hits Iran's Nuc sites, you might see a dollar rally and an Oil spike at the same time.

2008 Jul 28 09:29 AM

[OldLimey:]

Dumping on Europe to jaw-bone the dollar higher seems to be fashionable right now; maybe its cathartic as well. But from this side of the Atlantic (i.e., the old, sclerotic, socialist side) the dollar still looks like a currency for short-term trading rather than medium- or long-term investing. Sound fiscal and monetary policies could change that assessment, but it's difficult to see where they will come from. As for US interest rates going up some time soon - I've no more idea than anybody else, but I wonder whether the US financial system is going to be strong enough over the next 6-12 months (even assuming that the economy is).

2008 Jul 28 09:41 AM

[robert.b.fe...:]

We have seen over several months massive write downs from most U.S. banks. Bond insurers Ambak and MBIA are all but gone and other U.S. financials exposed to worthless derivativs are barely hanging on or have been snapped up by more stable financial entities. What we havn't seen yet is the other shoe dropping in europe. Some of Europes financials have yet to disclose their exposure and when they do we will see wich pig looks best in lipstick.

2008 Jul 28 09:55 AM

[think befor...:]

The irony of the national debt going to 1 trillion dollars is that by that time the dollar won't be worth anything.

2008 Jul 28 10:18 AM

[Tobogan:]

I'm not an expert but I think the scale of changes at play is bigger than most people think. The US became a global economic power with the advent of the 20th century, economic power shifting from Europe to US: Guess what we're observing? The shift from US to Asia, with Europe trying to keep itself relevant, as usual. But above all, there is no evidence that the US crisis is close to self-resolution. Whatever the model you use, it always boils down to a confrontation; and at present, the US economy is not able to withstand the massive impact of both a weak dollar and record breaking oil prices.

2008 Jul 28 10:20 AM

[bearfund:]

"The Fed and Treasury now see a stronger dollar as strategically important in battling inflation and the credit crunch fallout."

Which is why they've raised interest rates 7 times in the past ... oh, wait. I meant cut; that's why they've cut interest rates 7 times in the past year. To keep the dollar strong. It's worked, too; it's up almost 3% from its all-time low. And with the fancy new colours on the notes, further strength is sure to follow.

2008 Jul 28 10:24 AM

[sickofthehype:]

It's all a game, and it's all planned. A weak dollar was on the agenda, but going forward there are no more rate cuts. The strengthening will occur, regardless of the poor situation we're in right now.

2008 Jul 28 10:27 AM

[Dean Plassaras:]

I find very little evidence in this article to support its thesis. Relative strength based on the weakness of others, might not be strength at all; only hope of such.

2008 Jul 28 11:03 AM

[Chris Lau:]

I'm not so sure the Fed would want to raise rates. Raising rates has no impact on the price of oil or the price of food. The Govt is focused right now on loosening the credit markets and as such need to leave rates where they are.

2008 Jul 28 11:07 AM

[GMiki1:]

The triumph of hope against experience--or reality. Hahahaha. Yes, some people believe what you've written, but belief and facts are two different things. We're definitely in a period of total change and the decline of the U.S. as a world power. That's what happens when you lose your moral compass as Wall Street and Washington have.

2008 Jul 28 11:13 AM

[secmaven:]

Demand destruction in gold? Since GLD was offered investors have purchased 600 Million ounces supplied by the central banks. Supply reduction of gold is the real deal. Mine production is down and the central banks are now funding shell corporations to sell paper shorts through the bullion banks on the Comex to control the gold market because their physical supplies available for sale or lease are exhausted. As inflation roars in far off lands the citizens of those countries will turn to gold and silver in self protection. Ultimately, physical demand from this source will trump the paper manipulation of these markets and drive prices up. The dollar may become the "strongest" of a weak lot of fiat money but gold and silver will be stronger yet. We are just waiting for another shoe to drop to reveal that strength. This shoe could be anything from a "terrorist" attack timed to influence the US election to the bankruptcy of a MS.

2008 Jul 28 11:13 AM

[Coelacanth:]

German consumer confidence at a 5 year low, Euro-zone & German June PMI reads all below 50 (denoting a contraction of manufacuturing), German Business sentiment IFO reads dropping below the psychologically important 100 mark, Industrial output for the euro-zone falling 3 months straight, French consumer spending falling off, etc.......many economists out of the euro-zone are now saying the EU block probably contracted in the 2nd qtr. (As a reminder.....the U.S. hasn't experienced negative growth yet)

One could argue that between the euro & dollar it's a "battle of the ugly ducklings" at the moment but it seems clear to me, despite all our troubles that are pretty much all priced in to the buck by now, that the euro is wildly over-valued relative to the dollar and yen given their medium term fundamentals.

It won't be a straight line but don't be surprised to see the euro around the 1.45 - 1.50 handles in 6 months to a year.....if even that long.

2008 Jul 28 12:56 PM

[carey_jim:]

I have no crystal ball except the one illuminating the past and even that one is cloudy.

Bretton Woods should remind us that anything is possible and the state of Russia today should remind us that capitalism doesn't always work better than socialism.

But sometimes socialism and capitalism are thrust upon us underlings. Food for thought.

2008 Jul 28 01:02 PM

[montross515:]

One bankrupt to his wife, "We are actually pretty well off; that guy over there owes his creditors ten million and we are only under water by $250,000."

Broke is broke.

If you think the USA is going to walk tall out of a situation where we produce very little of value and consume twice our income, please sell me your gold, or better yet, your silver. Little metal coins can't be important like a big roll of $100s.

2008 Jul 28 06:18 PM

[fx maven:]

the USD will not appreciate as long as real yields are negative. At least EUR has a real yield at all .; 5%-1%. This basic fact, plus the fiscal collapse of the US Government, the continued implosion of the US housing market, and the banks who are tied to this albatross make the dollar fatally weak. Yes, Eurozone has its own problems (Spain, Italy) - in sum The premise of the article is good but the monikers USD and EUR should be reversed.

2008 Jul 28 08:03 PM

[Soccerfanyes:]

Yep, Greenspan and Jack Welch were both emperors who don't look so good without their clothes. (Who disses their handpicked successor on TV as Welch did to poor Jeff Immelt?) Back to the dollar, this guy Bernanke is actually what Greenspan wishes he was. He's making the right moves at the right time, and the Euro crowd will realize that you can't have slower growth in a $13 trillion GDP market and not have it affect your business. Bottom line . . . the $ is at the low point now.

2008 Jul 28 08:27 PM

[Steven Hansen:]

although i agree with this article, we should remember that it is an opinion as little proof was offered of things to come.

it with the fragile state of the world economy, it will not take much of an unexpected event to have the markets spiral out of control.

another point to remember is that we have been shown little data on the state of us banks or i-banks. only rumors and speculation and opinion. again, any event or leak of raw data which contradicts what we think is true will send the markets into a death spiral.

2008 Jul 28 10:55 PM

[NOWHEREMAN:]

Euro will be at 1.65 before Dec 08.

Before the latest shoe to drop, European Banks had more in writeoffs than US banks. The US banks are still using Level 3 to store unmarketable "assets".

I don't know what Goldman has for the 2nd quarter yet but they had 90 billion on this level at end of first.

Like Grossman says "expect a Trillion" in losses by US banks before all is said and done.

Losses on this scale will not strenghten the Dollar.


BUT, a War will do it on a short term basis.

2008 Jul 28 11:55 PM

[Packertex:]

If I understand you correctly, the Euro, Sterling, and Yen are also terrible fiat currencies so this will help the dollar. Don't you think it is possible that the public and businesses worldwide will reject all of the worthless currencies and replace them with gold and silver?

Not a single fiat currency has ever lasted. Maybe we will get the Amero?

2008 Jul 29 11:53 PM