"We have, in this
country, one of the most corrupt institutions the world has ever known. I
refer to the Federal Reserve Board. This evil institution has impoverished
the people of the United States and has practically bankrupted our
government. It has done this through the corrupt practices of the moneyed
vultures who control it".
~ Congressman Louis T.
McFadden in 1932 (Rep. Pa)
The above quote coming from
the Honorable Louis T. McFadden is a quite prescient statement as it relates
to arguably the most evil enterprise in American history.
The Federal Reserve through
its various monetary mechanisms has a major impact on the value of the U.S.
Dollar and over time has destroyed the purchasing power of the fiat base
currency used in the United States.
Interestingly enough, the
following quote comes directly from the Federal Reserve's website regarding
one of its primary mandates, "In setting monetary policy, the Committee
seeks to mitigate deviations of inflation from its longer-run goal and
deviations of employment from the Committee's assessment of its maximum
level."
The chart below illustrates
the horrific job the Federal Reserve has done of protecting the purchasing
power of the U.S. Dollar since its creation.
In light of the longer-term
malaise seen above, the Dollar Index futures have recently rallied sharply
higher as Europe continues to flail in a slow and agonizing decline which
will ultimately lead to a complete fiscal disaster.
Sovereign debt concerns
continue to mount regardless of what the European technocrats spew publicly
and the U.S. Dollar has been the primary beneficiary of these seemingly
growing concerns.
This brings me to the purpose
of this article. Most of the articles I write are focused on option based
trades, but I decided it was time to put forth a more comprehensive scenario
that could unfold over the next few years as a result of excessive monetary stimulus
through various quantitative easing mechanisms developed by the Federal
Reserve Bank. "A mild change" to say the least . . .
As discussed above, the U.S.
Dollar Index futures have moved higher throughout most of 2012. Any
significant increase in the U.S. Dollar is a growing concern among central
bankers as it correlates toward deflation. Deflation is the Fed's biggest
enemy, besides themselves of course.
Next week the Federal Reserve
will release statements relating to the economic condition of the United
States. Furthermore, the Fed also will discuss if it will initiate another
dose of monetary crack for a capital market place that is addicted to cheap
money and zero interest rates. At this point, the so-called marketplace is
the antithesis of free by all standard measures.
Consider the long-term
monthly chart of the U.S. Dollar Index futures illustrated below:
The U.S. Dollar Index futures
are in an uptrend that dates back to mid 2011. The orange line illustrates
the uptrend and represents a key price level for the U.S. Dollar Index. For
those unfamiliar with basic technical analysis, the rising orange trendline
will act as buying support until the Dollar eventually breaks down through it
signaling the bullish move higher has ended.
This brings us to a rather
interesting potential observation. Today Mario Draghi, Chairman of the
European Central Bank (ECB), made public comments regarding the readiness of
the ECB to act if need be to safeguard the European Union. The Dollar Index
Futures plummeted on the statement and remained under selling pressure most
of the trading session on Thursday.
If a mere comment from the ECB
can have such a damaging impact on the valuation of the Dollar, what would
happen to the Dollar if the Fed initiated a new easing mechanism?
The answer is simple, the U.S.
Dollar would immediately be under selling pressure. Selling pressure in the
U.S. Dollar Index generally leads to a rally in risk assets such as equities
and oil futures. Over the longer-term, a weak Dollar is also positive for
precious metals and other hard assets.
As an example to illustrate
the power of Quantitative Easing as it relates to the price of both gold and
oil, consider the following chart:
Obviously the price action is
pretty clear that Quantitative Easing has a positively correlated impact on
the price performance of hard assets, specifically gold and oil. Now consider
a price chart of the Dollar Index shown below courtesy of the Federal Reserve
Bank, the annotations are mine.
The chart above tells an
interesting story about the impact that Quantitative Easing has on the
Dollar. How can the Federal Reserve claim to be protecting the purchasing
power of the U.S. Dollar when its actions have a direct negative correlation
to the greenback's price?
Furthermore, based on the
chart above I am of the opinion that Quantitative Easing III is a foregone
conclusion. The current price of the Dollar Index is clearly above the
previous high where QE2 was launched.
So far, the rally in the
Dollar Index has not pushed equity prices considerably lower. However, should
the Federal Reserve refrain from initiating additional easing measures it is
likely based on the chart above that the U.S. Dollar Index will rally.
Upon the conclusion of both QE
and QE2, the Dollar Index rallied sharply higher. With the Fed announcement
coming closer by the hour, financial pundits will attempt to predict the
future action of the Fed.
I have no interest in making
predictions about what the Fed will do. It is a certainty that QE3 will take
place at some point in the future whether it be sooner or later.
The Federal Reserve simply has
no choice, otherwise the Dollar would continue to rally and we would begin to
go through a deflationary period which the Federal Reserve simply cannot
tolerate.
The scenario that I would urge
inquiring minds to consider would be as follows. If the Fed does nothing we
can likely assume that the U.S. Dollar Index will continue to rally to the
upside.
Based on the price chart of
the U.S. Dollar Index shown above, we can expect that sellers would certainly
step in around the 86 - 88 price range based on previous resistance.
If the U.S. Dollar makes it
anywhere near the 86 - 88 price range without the Federal Reserve initiating
QE3 it would be expected that risk assets would be under considerable selling
pressure somewhere along the way.
Should the Fed act to break
the Dollar's rally either through more easing or "other"
mechanisms, the result would be a potentially monster rally for risk assets,
at least initially.
Equities, oil, and precious
metals would rally on a falling Dollar as shown above. The question then
becomes what if this is the last gasp rally before a monster selloff ensues
in the Dollar Index?
If the Fed breaks the rally early
or initiates a monster-sized easing program, the initial reaction will be
quite positive, especially for equities. As the selloff in the Dollar Index
worsens, equities would eventually begin to underperform as oil prices would
surge putting pressure on the economy.
In addition to oil rallying on
the weaker Dollar, we could also see sellers start to show up in droves
dumping U.S. Treasury's to any buyer left standing. International debt
holders would especially have incentive to sell Treasury's as the real
purchasing power of the bonds' interest payments would decline as the Dollar
fell in value.
The way I see it, whether the
Fed launches QE3 now or later, the outcome will not change. An extremely weak
Dollar could wreak havoc across a variety of assets and the broader economy.
Imagine where gasoline prices would be if oil prices hit $125 / barrel. The
average price in the U.S. would be well above $5 / gallon based on current
prices and possibly higher.
What happens to the economy if
interest rates start to react violently to the price action in the Dollar?
What if Treasury's start to sell off viciously and interest rates start to
rise wildly and volatility among bond holdings runs rampant?
Are we to believe that the
very entity that has created boom and bust cycles through easy monetary
policies and has been oblivious to the bubbles that it has created is capable
of solving the issues that would potentially arise from a currency crash in
the U.S. Dollar?
The track record of the
Federal Reserve is quite clear. They are generally late to the party and
rarely are able to forecast events in the future with any clarity. Do you
really think they will know what to do? The free market wants to destroy debt
through deflationary pressure and price discovery and the Federal Reserve
continues to get in the way.
The free market will win as it
always does, but the American people will lose. This process may take months,
years, or even decades to play out. Eventually the game will end.
There is only one certainty
should any portion of the scenario discussed above come to fruition, when the
Dollar is inevitably broken the only safe place to hide during the potential
currency crash will be in physical gold and silver. Paper money and paper
assets will come under extreme selling pressure and in some cases will simply
. . . disappear.
Here's to hoping I am totally
wrong!
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