Greenback slumped on the canvas

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Bernanke & Co. on Tuesday signaled to the financial markets that they were hell-bent on pursuing an “inflate or die” approach to rescuing the ailing US economy and fending off the forces of deflation. The Fed is now inflating at a level possibly not seen before by a developed nation since Weimar Germany.

Since the credit crisis started intensifying in July, the dollar benefited from a global flight to safety in US Treasuries and a scramble for dollars to repay USD-denominated debt. The deleveraging process effectively created a short position in the greenback.

But more recently, US-specific worries concerned with public debt expansion and the potential inflationary implications of quantitative easing dawned upon battle-weary investors, causing the dollar to reverse the uptrend that had commenced in July.

The US Dollar Index (i.e. a trade-weighted basket) has not only breached its 50-day moving average convincingly, but seems to be forming a top of at least medium-term significance (see chart below). The fall from grace was brutal with the Index recording its largest six-day decline (from December 10 to 17) ever, setting up an assault on the key 200-day line (often seen as a crude indicator of the primary trend).


The US currency also suffered its biggest one-day slide against the euro on Tuesday, and plunged to a 13-year low against the Japanese yen. (Also see my weekly “Words from the Wise” review for comments on currency movements.)

The table below shows the performance of the US Dollar Index, as well as a number of major and emerging-market currencies against the US currency. Gains against the US dollar (green) / losses (red) are given for (1) the period since the dollar’s high of November 20, (2) the period from the dollar’s July 21 low until the November high, and (3) the year to date.

Click on the image for a larger table.


The devaluation of the US dollar de facto exports deflation and depression, raising the question of how long it will take before other countries retaliate and embark on “beggar thy neighbor” currency debasement. China is already in the process of “managing” the renminbi lower, Russia’s central bank has signaled it would step up devaluation, and the Bank of Japan and others might also consider intervention.

“Either we are going to pay for our policy sins via higher interest rates or a weaker dollar. And for an economy that is as levered as the one in the US is, the former choice is not an option,” said Stephanie Pomboy (MacroMavens). “So a weaker dollar is the natural valve.”

US creditors – such as China – with large hoards of dollars are growing increasingly nervous, and the dollar is likely to come under additional pressure if foreigners stop finding dollar assets an attractive proposition. The only way the US can attract foreign capital is by offering a higher interest rate or making its assets cheaper through a weaker currency.

Jim Rogers commented as follows in a Bloomberg interview: “… the dollar is a terribly flawed currency. I hate to say it, but my goodness, they’ve messed up the dollar badly. So, I don’t like to do it, but I’m going to sell all the rest of my dollars sometime in the next few days, weeks, or months … Again, I don’t like saying it, but I’m afraid the dollar is going to go the way the pound sterling went.”

The speed of the dollar’s decline has been such that it is quite likely to see a relief rally before the downtrend resumes. Arguing for a temporary hiatus from a fundamental viewpoint, Stephanie Pomboy said: “… right now, we are enjoying some real competition in the ugly contest from the currencies of the European Union and the United Kingdom, and that will probably persist for a while because they are in pretty bad shape, and they are a little bit behind the curve relative to us.”

Lastly, a sustained break in the uptrends of the US dollar and the Japanese yen – low-yielding currencies previously used for funding risky investments – should indicate that forced selling due to deleveraging is starting to subside. As this situation plays itself out, we should see a return of confidence and a calmer period for stock markets in general, and also some support for precious metals and commodities. The dollar may be down for the count, but could herald a sense of normalcy in broader markets.


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6 comments to Greenback slumped on the canvas

  • Greenback slumped on the canvas…

    Since the credit crisis started intensifying, the dollar benefited from a global flight to safety in US Treasuries and a scramble for dollars to repay USD-denominated debt. But more recently, US-specific worries caused the dollar to reverse the uptrend…

  • Anonym

    Dollar is not safe-haven. Treasuries are toxic waste. Fed will punish those who hold on to dollar and who save. Fed will force people to take risk and to lose principle one way or the other.

  • xoted

    I think the US has done this before. It’s a great post transactional (& negotiation) tactic.

    Get in debt,
    debase the currency,
    Get what you got for less money,
    by paying with undervalued dollars.

    It also auto-penalizes. If other countries try to sell the US dollar, it drives the dollar down further, making what they retain, worth less. What a beautifull Catch 22.

    Absolutely brilliant retaliatory move against those who manipulated their currencies and trading practices during the “good times.”

  • GJ

    USD should have fallen many months ago; the fall now is just a delayed event. Looks like the fall is going to deep and prolonged…

  • […] Investors’ concerns about the outlook for the global economy deepened on the back of the Fed’s announcement, as seen from government bond yields plunging to record lows and a sharp sell-off in oil prices (despite the announcement of the largest supply cut in Opec’s history). Furthermore, the dollar also tumbled on worries about the US’s public debt expansion and the potential inflationary implications of the “printing press”, although a relief rally did take place on Friday. (Also see my post “Greenback slumped on the canvas”.) […]

  • Good point that USD devaluation is the only escape valve for American policymakers. There is no way they will raise rates, so we will continue to see USD flooding the markets. Worse yet, as foreign governments come under increasing pressure, they will begin liquidation of USD and USD-denominated assets to fund domestic shortfalls.

    In addition to the Federal Reserve, we have a very “generous” Congress and incoming President who intend to borrow and spend to the maximum extent possible.

    All in all, the USD is shot. Its only saving grace might be that other fiat currencies follow suit in the race to debasement, enabling it to hold some relative value.

    My fund is heavily short USD and fiat currencies in general, going long gold.

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