We have watched, even marveled at how the U.S. dollar has strengthened
since last September. All sorts of theories have been put forth as to
“why”. Some have proffered the dollar is the cleanest dirty shirt of
the bunch. Others believe the interest rate differential is kicking in
where dollars at least have a positive interest rate versus negative rates
elsewhere. Another theory and one which I have written about in the
past and believe to be the main reason for dollar strength is the “margin
call” aspect. In other words, the “carry trade” which was used to
leverage all sorts of trades is unwinding and dollars are needed to pay back
the loans. A synthetic dollar short being covered in other words.
Looking back to my writing yesterday regarding the impossibility in my
mind of the Fed actually raising rates, the strong dollar also supports this
argument. If the Fed were to raise rates, wouldn’t this exacerbate an
already immense currency cross problem with (for) the rest of the
world? Wouldn’t higher U.S. rates explode the dollar higher (short
term) versus foreign currencies? The answer of course is yes, but with
a stronger dollar comes other obvious problems.
The two biggest problems are A. we still have a trade deficit of
close to $500 billion per year, a stronger dollar will only exacerbate this
AND destroy what little manufacturing we have left. And B. the
very problems we just saw with a soaring Swiss franc will be seen in many
multiples throughout the dollar lending market. I might add, as the
dollar moves higher and foreign currencies drop, more and much stronger
inflation gets exported to foreign soil. High and rising inflation and
its effects on living standards and the human psyche will create massive
unrest across Europe and elsewhere.
This last point is an important one, foreigners who have borrowed in
dollars have already seen their “loan balance” expand because the
dollars cost more to pay back. Higher U.S. interest rates will only
make matters worse. The strong dollar has had the effect of slowing the
global economy as companies (and individuals) are cutting back (employment
and consumption) to make ends meet.
The above is only half of the equation, the other half is described by
Alan Greenspan himself. I personally watched Mr. Greenspan speak
in New Orleans last October. He used the word “tinder“ for a coming
inflation several times and spoke of the money supply and reserves of
dollars that have been created and parked away on bank balance sheets.
I could only think back to the Texas wildfire as he spoke of “tinder”.
The amount of dollars created is like some nutcase piling dry leaves, branches
and dead trees in a huge pile, then pouring gasoline on it …and thinking to
himself, “this will keep me warm in winter”. In other words, the “fuel”
is there and has already been created for a bonfire of inflation and the
financial system blowing up on itself. But don’t worry, it will never
catch fire?
Tying these two phenomena together, not enough dollars, yet too many, here
is the likely scenario I can see unfolding. The stronger dollar is
putting pressure on the financial system all over the world, something
(someone), somewhere is going to “fail”. Our financial system is so
interconnected and over levered, it will only take one strategic
institution’s failure to break the derivatives daisy chain. Let’s call
this the “spark”. This spark causes further failures which I am
convinced will circle the globe in less than two days. The forest
(economy and financial system) is very dry (weak, fragile), any spark
(failure) will create an out of control forest fire which will not be put out
until all the fuel is burned and blackened.
Please remember this, the dollar (and Treasuries) are now “backed” by the
full faith and credit of the United States. This was not the case back
in the 1930′s, dollars were backed by gold. The Treasury did not have
enough gold to back all of the dollars but for a very large percentage of
those outstanding. This is not even close to the case today. It
remains to be seen if there is any gold at all left but, assuming the
gold is left untouched, gold would need to be priced at $100,000+ per ounce
to cover our debt and money supply. I bring this up because “gold
will still be gold” no matter what happens financially. Hold
this thought, it ties in with the final logic.
The stronger dollar is beginning to cause stress both financially and
economically. It is not “official” yet but even with bogus reporting,
the West is already in recession while the East is markedly slowing
down. This brings up a few questions. With a slowing or declining
economy, will the Treasury have the tax revenues to pay total interest and
support all of the other largesse? Of course not, we will just borrow
whatever is necessary to keep going on down the road. What
about higher interest rates, will this exacerbate the problem? Of course.
Tax revenues will drop, “benefits” or spending will rise as will the
deficit…and now the federal debt is almost double what it was last time
around in 2008. Do you see where this leads? Is the “issuer” of
dollars stronger, or weaker than it was in 2008? It’s OK, you can admit
it. Weaker. In this scenario where a higher dollar (the spark)
puts so much pressure on financial counter parties who are short the dollar,
what will be the Feds reaction to derivatives or other sovereign currency
crises? Does the Fed have to quintuple their balance sheet again?
Or the federal debt double again? Or will another secret $16
trillion or a multiple thereof be lent out all over the world by
necessity?
Looking at this in the real world, there have already been many markets
thrown into upheaval. The two most important being the FOREX crosses
and the oil market. Oil without a doubt is the largest and most all
encompassing market on the planet with the exception of dollars
themselves. Oil has crashed well over 50% in less than 6 months, dollars
have risen 25% over this time frame. Do you think that these
percentages when applied to $10′s of trillions might add up to a tad more
than a tidy sum? Remember, derivatives is a zero sum game so anything
“won” is also “lost”. I believe the spark has already created a fire
behind the scenes and some have already been consumed and are dead, but
hidden. Can I know this for sure? No, but common sense and the
amounts involved tell me this is 100% dead on! And there you have it folks,
there are too may dollars outstanding …which were created by too much
borrowing of dollars … This pushed asset values higher until the world
reached debt saturation and led to assets being sold to pay back the debt,
asset prices dropped which is causing a global margin call…this
synthetic short has created dollar demand to pay these dollars
back. In essence creating a dollar shortage. Are you
still with me after that long and horrible string of sentences? If you
are, then here we are …facing the global margin call which can ONLY be met by
central banks printing more dollars, euros, yen etc. because liquidity is
again drying up. The alternative of course is to let the margin call
run its course and take all banks, brokers and insurance companies
down. Oh yes, don’t forget the sovereign treasuries and central banks
themselves. It is the solvency of these institution that will
ultimately be challenged.
And no, I didn’t forget I told you to “hold that thought” for the
end. What I have described to you is the world running around and
fetching as much wood and pouring as much gasoline on the pile as
possible. The thought is this, without a spark this is harmless
right? Without going into static electricity, spontaneous
combustion, a “gun” or even a BIC lighter for that matter, is it even
sane? Gold and silver do not and will not burn. Whether it
be a wildfire, a derivatives core meltdown, or even a central bank (like the
Fed) or a sovereign treasury going upside down, gold will remain money
and remain the benchmark against which currencies are measured. Fiat
currencies by definition are “terminal” at their inception. The
“deflation/inflation” debate is a moot point unless argued in terms of real
money.