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Cracks in the Dollar: 20 Things You Need to Know


We're left to wonder how much patience international investors have left and how they can unwind their dollar-denominated positions without committing the financial equivalent of hara-kiri.


"Money, it's a gas. Grab that cash with both hands and make a stash."
-Pink Floyd

As the dollar flirts with long-term support and multi-year lows, a few folks have asked about the implications. While we've spoken about this dynamic incessantly over the years, we also understand that there is renewed interest in the subject.

As such, and in the interest of education, we offer 20 things you need to know about the greenback.

  • First, what is the dollar? Kevin Depew wrote a fantastic primer that should be required reading on the subject. (See the MV article Special Edition Five Things: Five Things You Need to Know About the Dollar.)

  • The Federal Reserve essentially published money to infuse capital into the market machination on the back of the tech bubble. The more supply there is of something, the less it is valued. It's really that simple.

  • Since the beginning of 2002, the dollar is off 33% largely as a function of supply. (See dollar chart.)

  • How much money has the Fed published? It's tough to tell-it stopped calculating the M3 (money supply) in the spring of 2006.

  • The rising tide of liquidity has lifted all asset class boats, from stocks to gold to crude.

  • That's why we often say that we'll likely toggle between "asset class deflation" or "dollar devaluation." We could see both but I don't foresee a scenario that includes a stronger dollar and higher asset classes.

  • Stateside, folks were somewhat slow to embrace the notion that the basis of valuation was eroding. They earn, spend and "save" dollars so, apples to apples, there was little impetus to pay attention.

  • Foreign holders of dollar denominated assets aren't as apathetic, as evidenced by the sowing seeds of nationalism. Think about it: if you're an international investor and bought the S&P in 2002, you've lost money during the last five years. That's a tough nut to digest.

  • The Federal Reserve, in an extreme scenario, would opt for hyper-inflation versus watershed deflation. It's the whole "devil you know" train of thought. With inflation, the rich get richer and the poor get poorer. With deflation, everyone loses.

  • Wasn't it Billy Ray Valentine that said "the best way to hurt rich people is by turning them into poor people?"

  • Now, however, there's an added twist: globalization. International investors own over 50% of the U.S.' total debt, which basically means that they're holding the trump card on policy.

  • It's my opinion that the FOMC kept a tightening bias at the last meeting to appease those foreign holders of dollar-denominated securities despite the need to lower rates to spark demand and prod consumers to consume. (See the MV article The Master of the Fed Domain.)

  • In our finance-based economy, the velocity of money and elasticity of debt are essential ingredients to the upside equation.

  • The crux of the credit crunch is that it brought this conundrum to bear.

  • The FOMC is now in a position where the market is demanding that it cuts rates (and Fed Fund futures suggest that it will), which lowers the value of the dollar

  • All things being equal, this could be "asset class positive" under the rising tide thesis discussed earlier.

  • At the end of the day, however, we're left to wonder how much patience international investors have left and how they can unwind their dollar-denominated positions without committing the financial equivalent of hara-kiri.

  • And it leaves us, investors, in the unenviable position of gaming an invisible catalyst.

  • For regardless of whether we're wading into inflation, deflation or both, a natural question is begged.

  • How do you shoot the devil in the back? What if you miss?
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