Investors Now Treating Bad News for the Dollar as Bad News

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After last week’s thumping at the hand of all its major counterparts, the dollar is looking to me like Charles Atlas’ 98-pound weakling from the old comic book ads. Sand is getting kicked in its face from every bully on the beach. Even the lowly yen, with its pacesetting negative GDP (a negative 250% of the United States), is kicking the dollar’s bootie.

When this rot began to be exposed, I often reported that things had been turned on their head in the currency world. Bad news for the U.S. economy became good news for the currency. Why?

Basically, risk aversion settled over the market. People and governments were fearful. And since currencies tend to be considered risky investments, investors avoided them. In short, the worse the news for the U.S. dollar was, the more money flowed into the it.

But you cannot, under any circumstances, run contrary to the law of supply and demand forever. It’s just impossible. Therefore, at some point, a return to fundamentals reverses the current perverted trends.

And as of last week, fundamentals have showed back up on the stage. For the first time in a long time, investors are treating bad news for the dollar as bad news for the dollar. So let’s take a peek here and see what we have.

Initial jobless claims rose again last week. This time to 637,000, which was higher than forecast, and the previous week’s number was revised upward. In addition, continuing claims for unemployment came in higher as well – 16 straight weeks of increases.

The Federal Open Market Committee also hung the markets out to dry. You see, the Fed heads discussed the weakened condition of the economy at their meeting. They also revised their economic projections for 2009 and 2010 lower.

Here was the key. They DID NOT PURCHASE as many Treasuries as the markets believed they would – part of the infamous quantitative easing. Now, at first blush, we would be happy about that. But once we lift the Feds’ curtain on this act, things are not what they seem. The market’s reaction assumed that a less-than-stellar bond purchase number portends that the Fed will have to purchase more later on.

At this point all factions are feeling the squeeze.

The Feds know they cannot continue to inflate as they have indicated. While runaway inflation remains a threat, the bigger problem is whether or not traders and investors (including the sovereign states who buy our debt and support our spending addiction) will pull the plug on the dollar.

If such massive selling occurs, that only leaves them the option of perpetually inflating the currency, since borrowing becomes out of the question.

Nobody wants to be the last one out the door once that begins. As of now, the Fed still has a little opportunity to actually control the hyper inflation scourge, but if they tip the scale just a bit too much and the selling begins full force, control will be out of their hands entirely.

Interestingly, the whole tenor of the minutes from the Fed meeting indicates that the worst is still ahead. Yet Ben Bernanke and company are still telling the public about “green shoots” – small signs that things are improving.

Bill Bonner shares a headline from Politico last week: “Obama Would Regulate New ‘Bubbles.'”

Oh, the sheer absurdity of it all! We have a government that doesn’t even seem to know where bubbles come from. They don’t know how they work. They don’t know why they keep inflating. They don’t understand why you can’t deflate them slowly. In short, an administration with a rudimentary understanding of economics is confident it can regulate the next bubble – whatever it might be.

But I suppose that is the plan of all governmental types. Whatever doesn’t work needs more regulation.

What we need is to be left alone. The market has been, and remains, the most efficient system for regulating itself. Is it perfect? Not in a moral or theological sense. Not even in a fairness sense. The market will make some men rich while impoverishing others. Many people do not consider that “fair.” But it doesn’t matter. The market does what it does, because it is the most efficient way to do things. Regulation be hanged, the market will undo regulation and tyranny, because free markets create free men. And on its way to undo the foolishness of men, it will cause great inequalities. Why? Because of the foolish restraints that governmental do-gooders have foisted upon it in the name of “fairness.”

The ironic thing is, bubbles are created by regulation. You can’t undo them with more of the same.

Since the government has had such a great track record with spending and credit, now they want to get their greedy little paws into the credit card business, too. Apparently, it’s not enough for them to control the major banks, or the once monstrous auto industry. The heady days of markets free from governmental interference are going the way of the dinosaur.

Our Senate, by an overwhelming majority, passed a new bill that would dramatically impinge on the credit card company’s policies to alter rates and fees.

Now, I am not going to bat for the credit card companies. Frankly, they have abused people for years. As a younger man, I, too, enjoyed the pleasures of free money being offered by these benevolent giants. Every time my wife and I got a new card, we treated it like a raise.

Before long, the handwriting was evident on the wall, and I didn’t like what it said. So we got out. Don’t get me wrong, I still use my credit cards. But they no longer own me. Yet the number of my friends and relatives who are slaves to these things is atrocious. In sum, I have no love loss for these companies and how they try to enslave people.

But I will stand and declare their right to do it as a free market entity as long as people will keep applying. The fact is, if and when the credit card companies get “out of hand,” the market will reign them in. We don’t need the government to do it. They won’t do it well anyway.

Meanwhile, the Federal Deposit Insurance Corporation (FDIC) suffered its biggest bank failure of 2009 last week. BankUnited FSB, Florida’s biggest regional lender, performed its final curtain call. Having over $20 billion in assets and deposits, it’s the biggest flop of the year, and the second biggest of the whole credit crunch (IndyMac still has that award).

BankUnited’s failure will take a $4.9 billion chunk out of the FDIC’s checkbook. It is the 34th bank to fail in the first five months of this year alone, compared to 25 for 12 months last year. A green shoot? Not hardly…

So on the edge of this knife, Big Ben and the Fed have to balance. That is, the Fed has to sell $3.25 trillion in Treasuries to fund this years’ obligations between now and September.

If the markets can absorb the U.S. issuance over the next 90-120 days…and if it is done without driving up interest rates…and if the economy begins to show signs of positive growth… then the stage is set for a wonderful second act. (And Bernanke might win an Oscar!) The dollar will return to strength. The market will continue, or resume, a climb to the top – sensing that “everything is coming up roses.” Refinancing will surge ahead. We may even see significant job creation into the end of the year.

At that point the Fed must begin to worry about inflation. Will the infantile recovery be strong enough to fight off a bout with interest rate increase flu?

I wouldn’t bet the farm on that.

On the other hand, if Treasury rates continue to rise as they already are, and the Fed is forced into extensive quantitative easing to contain them, then it may very well be curtains for the dollar. And the critic’s reviews won’t be kind.

Earlier this month, the dollar index fell below its 200 DMA for the first time since July 2008, and has been falling ever since. Not long after, the euro and sterling popped above their 200 DMA.

Of course, there’s probably a good reason why. The world is beginning to notice the U.S.’s monetary policies. Our rising deficits are eclipsing Mount Washington. Those deficits are going to need financing. And right now, the government doesn’t care – it’s still behaving recklessly because it thinks people will always be ready to buy its debt.

I wouldn’t be so sure. Consider the credit rating of Great Britain. Standard & Poor’s changed the outlook on the United Kingdom from stable to negative. Now, that’s not the same thing as a rating cut. But it does betray that the rating agency sees the nation on the wrong path. Continue on that path, and the outcome is guaranteed.

It doesn’t take an advanced degree in logic to apply the same principle to the United States. Indeed, I have wondered if all this was orchestrated for that purpose alone. It is far less damaging to downgrade a substantial nation like the United Kingdom than it is to downgrade the world’s reserve currency economy… the very definition of value.

But if it can happen in the United Kingdom, the United States had better be prepared. To that end, we heard Bill Gross, from PIMCO, the world’s largest and most influential bond trading firm, say that he believed the United States would eventually lose their AAA rating.

That’s scary stuff – but not all that surprising. After all, the administration is predicting a $1.8 trillion budget deficit. Perhaps more.

And where is GDP going? How much will it grow this year for all that fuel being added to the fire? It’s like adding a cast of thousands to a one-man show, just to try to give it a bigger billing. The expenses become monstrous, but no more people show up to pay the admission fee.

But the directors just want to keep adding more actors. At that point, the expenses of the show run absolutely in the opposite direction of the of the income. Until soon, the producers default on their lease, the curtain falls on the show and the affair is over.

When will the U.S. show be over?

Hard to say. But when your expenses are 650% of your income, it can’t go on for long. Not only is the curtain falling, the whole theater is collapsing around us. Better make sure you have a clear shot at the exit.

In fact, some U.S. businesses already are.

My home county has a few decent sized towns, but for the most part is still rural. Our biggest claim to fame is a section of famous U.S. Route 1 – the first route to run from New York to Miami along the East Coast. On our section of Rt. 1 has an abundance of auto dealers. But recently, the largest one put out one of those fancy electronic message boards. The advertisement read:

“NOW TAKING GOLD AND SILVER FOR YOUR VEHICLE DOWN PAYMENT.”

I’m pretty sure they’d be just as happy to take it for the entire payment as well. So who needs the U.S. dollar after all?

Regards,

Bill Jenkins
for The Daily Reckoning Australia

Bill Jenkins
Bill Jenkins, founder and managing editor of Master FX Options Trader, knows the Forex currency markets inside and out. After 20 years and a string of losses following other people's crack advice, Bill created his own system for cashing in on tiny currency fluctuations between the British pound and the U.S. dollar.
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Comments

  1. Please tell me…What bubble was cause by the Glass-Steagall Act? I thought that regulations were put in place to ensure “fairness” and to prevent unscrupulous and greedy bastards from getting rich at the expense of the public. You write about “fairness in the market place” as if its an abomination. And what free market are you referring to? Is it the FM that has been bestowed upon the people/farmers of Haiti, Mexico, India and South Korea? Dude, Are you on methamphetamines?

    Pookiedog
    May 29, 2009
    Reply
  2. Pookiedog – It’s a “chicken and egg” sort of argument. Although I think DR is pushing the view that problems are caused by socialism and well meaning though stupid regulators. And it was those same regulators that threw out the Glass-Steagall act, Yes?

    A fellow blogger on this site (Greg Atkinson) pointed me to an article by George Soros recently where Soros doesn’t seem to agree with DR – Leastways not fully – In that he reckons bubbles can be detected and contained – But it would require going back to some 1950s and 1960’s type US legislation.

    No point blaming bankers for mine – Pigs wallow in muck. Or consumers – Piglets suck on sow’s breasts. The problem is with the legislators – Though they have a very efficient PR machine in place to tell us why it isn’t so.

    Reply
  3. Nice article Bill. You mentioned how the markets are not necessarily morally (or theologically) fair, but that is not really fair on markets, or on Nature more generally. Pookiedog makes a good case for how markets are ‘unfair’, but again it’s missing the point. It’s people who are unfair, immoral and theologically corrupt. The idea of markets is morally neutral.

    Maybe there is excessive separation of Market (Commerce) and State, Church and State, Church and Market and so forth. As Chesterton stated “The modern world is full of the old Christian virtues gone mad” – there is clearly a tendency for people in markets to abuse their power, but it is not because markets are bad. It’s because governments are powerless in the face of markets, people are powerless in the face of governments, and so forth.

    All of the institutions: banks, government, markets, families can be forces of good (like virtues). But too much power and independence to one and the virtue becomes a vice. The problem in the US (and elsewhere) is that of a government on the loose (not effectively answerable to the people), markets on the loose (manipulated by banks and the Wall Street oligarchy) and people on the loose (drunk on media crap and without morals).

    As for solutions, I am too stupid to think of any good ones. But systems of socialism, or more of the same flavour of monopolistic capitalism that abounds (what’s the difference any way?), is probably worse than having no system at all.

    Reply
  4. There is no human solution Dan, but maybe you know that. The solution will come. By then we’ll all know how “stupid” we’ve been.

    Reply
  5. Lachlan: “no human solution” – that is a solution in itself. No people, no problems. As insane as it is, it’s a solution that hasn’t escaped the minds of the mega rich.

    Reply
  6. Eeeeek. OK I hadn’t thought of that one. Oh well as long as they take me quickly. Maybe I can swap them bullion in exchange for a more painless end.

    Reply
  7. epic Mr Jenkins.Just Epic.It’s so exciting to be alive right now . Your article was fantastic. I shall look at it again tomorrow when i’m sober.

    Reply
  8. Totally agree, Dan, its just about old-fashioned honesty.

    How do you teach people to be honest?
    With an honesty regulation?
    How do you ensure that the regulators are honest?
    Not legislatable.

    How do you encourage people to be honest?
    Thats only a question relevant to each individual in his or her life.
    The best means to encourage honesty is open communication.
    Every household NEEDS a dial-up connection,
    and FREE training on how to chat in forums and use the internet.
    If govt made any new regulations, that would be the most important.
    COMPULSORY INTERNET in every home.
    Perhaps make it only possible to vote online?

    Reply

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