From Almighty to Exhausted: The Dollar Needs a Good Night’s Rest

Happy Hump Day!  Today is Wednesday, of course.  Just a little more to go before the peak, then it’s downhill into Thursday and Friday.

Let’s have a look at the Dollar Formerly Known as Almighty.

Make Up Your Mind, “Almighty Dollar”!

I’m a massive fan of The Flashman Papers. If you’re a fan of historical fiction, and incredibly un-PC writing doesn’t offend you, then the 12 Flashman Books are right up your street.

I don’t want to give it all away, but Harry Flashman is a character from Tom Brown’s School Days that George Macdonald Fraser (GMF) “stole” and put into his own books.

Flashman is a coward, bully, bigamist, and poltroon, among other things.  But by the end of nearly every book, he always winds up getting promoted for some act of bravery he never actually committed.  Flashman is the missing man in many of the Victorian Era’s most significant battles, but he also is both a Union and Confederate soldier at different points.  The books are funny as hell but also richly educational.

My great friend and former trading compliance officer (I know!), the impossibly posh Ned, recommended them to me about 20 years ago when I lived in London. 

I vividly remember laughing so loudly on the train home one evening while reading Royal Flash that all the gloomy British heads turned around and stared at me, angry I had disturbed their collective misery with a belly laugh!

Perhaps the best part of Flashman, besides the humor and history, is the footnotes.  GMF was a journalist and veteran soldier.  He demonstrates his attention to detail in the meticulous footnotes.  GMF wrote them to clarify who and what the reader engages with.

One footnote from Flashman and The Dragon, incidentally one of my favorite of the books, reads

The expression ‘the almighty dollar,’ which now refers to the American currency, was applied to the Chinese currency in the last century.

The “last century” of the previous sentence is the 19th century, as GMF wrote most of the Flashman books in the 20th century.

Financial history thrills me.  It adds hard reality to the stories most historians conjure up to fit the limited set of facts they’ve discovered.

For instance, the next time a Brit tells you he drinks tea because it’s more refined than coffee, remind him that The East India Company’s monopoly on tea made it much cheaper than coffee way back in the day.  Also, remind him that the British government derived enormous tax revenue from tea and encouraged tea drinking over coffee consumption.

That’s not Charlie 2’s real hair!

Drinking tea actually made one middle class because all the “big wigs” were drinking coffee in Edward Lloyd’s coffeehouse.  (That’s not Charlie 2’s real hair!)  At Lloyd’s, they discussed things like their mistresses, stocks, and maritime insurance.  Of course, that’s now Lloyd’s of London.

I hope I imbue you with a deep love of financial history.  Not only is it richly rewarding on its own merits, but it gives you some great tools to see the big picture.

With all that said, let’s get onto that big picture of the almighty USD in the form of the Dollar Index.  The Dollar Index is the dollar’s value against a basket of six world currencies – Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona.

Here’s a long-term chart:

Dollar Index Chart

Let me talk you through it.

The USD massively rallied in the late 90s because US productivity went through the roof.  Internet and email led the way then.

Of course, the Nasdaq topped out in March 2000.  The USD initially held up but then began a relentless fall from the low 120s to the low 70s.

Think about it this way.  First, the Fed cuts rates all the way down to 1.00% (then a historical low) to stimulate the economy.  Remember, if rates get cut, the spot or cash price of the currency weakens.  If the currency weakens, you need more of it to buy stuff like stock.  So cheaper currency usually means stock prices increase.

Read about The Emperor’s Apples here to review our previous chat on inflation.

Starting in mid-2004, the Fed started to raise interest rates nearly every meeting.  This topped out in mid-2006 at 5.25% and stayed there until September 2007, when the Fed had a sneaky feeling something terrible would happen.  Of course, the financial crisis came soon after.

Despite the rate raises, the dollar kept falling until bottoming out in mid-2008.  Though the bull market began in March 2009, the following 6 years were choppy for the dollar index, as rates were zero.  But in mid-2014, the USD started to come back hard.  Until early 2017, the USD rallied; but it has been stuck in a range since then.

You can see at the far right of the chart, it’s that time again.  Will the USD rally back?  Or will it fall through that critical 90 level?

Based on Our Inflation Hypothesis, Let’s Assume USD Falls

Again, this is just a thought experiment.

But let’s say the USD falls through the 90 level.  There’s a lot of real estate between there and the low 70s.

Where will those dollars flow?

We’ve been talking about both gold and bitcoin for a while now.  They are the obvious choices.  But which is the preferred choice?

It’s easy to see BTC had jumped to $60,000.  At the time I am writing this – about 1:15 am EDT – it’s trading at $39,500.  That’s an ugly drop, any way you look at it.

Could people be moving from Bitcoin back into Gold as the safe haven of choice?

My erstwhile colleague Dan Amoss seems to think so, and it corroborates everything we’ve said over the past few weeks.

I copied and updated Dan’s charts from his report yesterday.

In the first orange chart, that plots Bitcoin’s price… right off a cliff.  The second chart is gold’s price, which we think will now head to $2,000 or thereabouts.  The third chart is the Bitcoin to gold ratio, which has collapsed alongside Bitcoin’s price.

Dan's Triple Chart

It may be that even the hippest, savviest investors are flooding back to the tangible assets and away from digital currencies.  It’s early days, but we can use that as our working hypothesis until more data comes in.

Central Banks and Foreign Buyers of US Treasuries

According to Bullion Vault, central banks were moderate buyers of gold in 2020 and are expected to remain so in 2021.

Central Bank Gold Buying Chart

Of course, that’s the tonnage they make public.  In truth, we don’t know what they’ve got or what they’re planning to do.  If they ramp up buying, the gold rally may happen a lot faster than usual.

What also seems interesting to me and may also contribute to dollar weakening is that the foreign buying of US treasury securities has dried up.  That doesn’t mean China and Japan are dumping their US treasury holdings and waging an economic war against America.  I checked, they certainly are not.  But they’re not rushing in to buy much more.

buying of US treasury securities

This will only make it harder to sell Treasury bonds.  That means yields will rise, and the Fed will have to buy more than they already are to keep yields down.

The Eccles Building should thoroughly look at James Grant’s idea of an Office of Unintended Consequences.

That’s all I’ve got for today.

Have a Super Wednesday!

All the best,

— Sean

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