Best of the Week
Most Popular
1.U.S. Housing Bull Market Over? House Prices Trend Forecast Current State - Nadeem_Walayat
2.The Coming U.S. Economic Collapse Will Trigger a Revolution - Harry_Dent
3. Stock Market Crash a Historical Pattern? - Wim_Grommen
4.Global Panic - U.S. Federal Government Stockpiling Ammo – Here’s What We’re Going to Do - Shah Gilani
5.AI, Robotics, and the Future of Jobs - Aaron Smith
6.This is Your Economic Recovery With and Without Drugs - James_Quinn
7.Gold and Silver Price Getting Set To Explode Higher - Austin_Galt
8.The Something for Nothing Society - Lifecycle of Bureaucracy - Ty_Andros
9.Another Interesting Stock Market Juncture - Tony_Caldaro
10.Inflation vs the Deflationary Straw Man - Gary_Tanashian
Last 5 days
Independent Scotland Currency, Plan A, B, C or D - British or Scottish Pound? - 2nd Sep 14
Gold and Silver Price A Critical Juncture - 2nd Sep 14
Gold and Silver Precious Metals Complex Contradiction and Potential - 2nd Sep 14
France And The Long-Gone Thatcher Moment - 2nd Sep 14
Stock Market Approaching An Important High? - 2nd Sep 14
Gold, Silver Price Summer Doldrums Coming to an End - 2nd Sep 14
The Ultimate Demise Of The Euro Union - 1st Sep 14
Palladium Price Breaks Multi-Year High Over $900 - 1st Sep 14
When Complexity Becomes Chaos - 1st Sep 14
Designer War By Default - 1st Sep 14
Islamic State or Russia? Ten Key Questions Towards Pragmatism - 1st Sep 14
Mixed Emotions for the Gold Market - 1st Sep 14
These Clowns Are Dragging Us Into War with Russia - 1st Sep 14
Marx And The Capitalist Cancer Of Overproduction - 1st Sep 14
Scottish Banks Salivating at the Prospects for an Independent Scotland of 6 Million Debt Slaves - 1st Sep 14
Small Man Europe Is Now In “Effective State Of War” With Russia - 31st Aug 14
The Unintended Blowback Of False Flags - 31st Aug 14
Tesco Supermarket Death Spiral Latest Profits Warning and Dividend Slashed - 31st Aug 14
Dow, Gold and Silver - A Last Stand, A Fake Out And A Surge - 31st Aug 14
If U.S. Consumers are so Confident Why aren't They Spending? - 31st Aug 14
Scotland Independence House Prices Crash, Deflationary Debt Death Spiral - 31st Aug 14
Obama’s “Catastrophic Defeat” in Ukraine - 30th Aug 14
Stock Market Inflection Point Approaching - 30th Aug 14
Gold And Silver - Elite's NWO Losing Traction. Expect More War - 30th Aug 14
Corporations Join Droves of Americans Renouncing US Citizenship - 30th Aug 14
Peter Schiff U.S. Housing Market, House Prices Bubble Warning - 30th Aug 14
Russia, Ukraine War - It’s Time to Play the “Gazprom Card” - 29th Aug 14
The One Tech Stock Investment You Should Never Sell - 29th Aug 14
Bitcoin Price $500 as Current Downside Barrier - 29th Aug 14
Don't Get Ruined by These 10 Popular Stock Market Investment Myths - 29th Aug 14
Low Cost Transcontinental Gold - 29th Aug 14
Gold Bullish Central Banks Should Give Money Directly To The People - Helicopter Janet? - 29th Aug 14
US House Prices Bull Market Over? Trend Forecast Video - 29th Aug 14
The Fed Meeting at Jackson Hole Exposed Yellen’s Greatest Weakness - 29th Aug 14
AAPL Apple Stock About To Get sMACked - 29th Aug 14
A History of Unlimited Money: Learn From It or Repeat Its Mistakes - 29th Aug 14
How You Can Play to Win When Market Makers Are Calling the Shots - 28th Aug 14
EU Gas Supply Is In Real And Imminent Danger - 28th Aug 14
Central Banks at the Root of Evil - 28th Aug 14
European Bond Market: Bubble of all Bubbles! - 28th Aug 14
Employers Aren’t Just Whining: The “Skills Gap” Is Real - 28th Aug 14
The ISIS Menace - Just What We Need, Another War - 27th Aug 14
The Risky Business of Methane-Rich “Fire Ice” - 27th Aug 14
CFR Recommends Policy Shift that is Very Bullish for Gold - 27th Aug 14
Ukraine Standoff Signals Global Power Shift - 27th Aug 14
Stock Market Panic Decline Begins - 27th Aug 14
The Monopoly of the Government Education Cartel - 27th Aug 14
How to Invest in Silver Today for Double-Digit Gains - 27th Aug 14
The Big Solar Energy Breakthrough We've Been Waiting For - 27th Aug 14
U.S. Empire’s Bumpy Ride - 27th Aug 14
Gold Market and the Interest Rate Trap - 27th Aug 14
Stock Market Staring Into the Great Abyss - 27th Aug 14
A Look at the Coming 30-year Inflation Cycle - 27th Aug 14
Forex Trading - Will USD/CHF Rally Above 0.9200? - 27th Aug 14
Europe’s Depressing Economy Dog Days of Summer - 27th Aug 14
How The Coming Silver Price Bubble Will Develop - 26th Aug 14
A Nation of Shopkeepers - Supply-Side (Voodoo) Economics? - 26th Aug 14
Stock Market Bear Tracks Abound In Wall Street - 26th Aug 14
65,000 U.S. Marines Hold up a Mirror to the Economy - 26th Aug 14
Bitcoin Market Provides Clues for Investors - 26th Aug 14
The Key to Trading Success - 26th Aug 14
Will The US Succeed in Breaking Russia to Maintain Dollar Hegemony?... - 26th Aug 14
Even Mainstream Academia Worried about Massive Bubbles in Markets - 26th Aug 14
Iraq and Syria Follow Lebanon's Precedent - 26th Aug 14
Colonization by Bankruptcy: The High-stakes Chess Match for Argentina - 26th Aug 14
Dow Stock Index On The Cusp - 26th Aug 14
Prohibition Laws and Agency Regulations - 26th Aug 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Biggest lie in Stock Market History Revealed

Huh? When the Fed Balance Sheet Expands, it’s actually U.S. Dollar Bullish!?

Currencies / US Dollar Jan 08, 2012 - 01:25 PM GMT

By: Aftab_Singh

Currencies

Best Financial Markets Analysis ArticleIf you ever happen to acquire an inclination for being the subject of disrepute and ridicule I highly recommend endorsing the conceit alluded to in the title. Apparently this issue is ‘so obvious’ that even gold bugs and government officials can reach common ground via the contention that I’m deluded. My folly — if you will — is to maintain that dollar debasement can be bullish for the dollar vis-à-vis other currencies at present. Since this long-standing conviction of ours is once again being corroborated by price action in the currency markets I thought I’d attempt to convince you that I’m not completely crazy. Here I outline why dollar debasement is bullish for the dollar against other fiat currencies in this environment.


Central Bank Notes & IOU Claims Upon Central Bank Notes:

This story should be familiar by now, but nevertheless it’s important to review it briefly: — from the early 1980s to the late 2000s the ‘private-sector’ was on a trajectory that involved ever-increasing doses of leverage. Towards the end of that period the economy reached a maximum capacity for leverage and thus the reverse corrective trend began. Since accumulating debt is like shorting Federal Reserve notes, the prospect that characterized the start of this corrective trend was a ‘short squeeze’ in Federal Reserve notes – i.e. a widespread appreciation of Federal Reserve notes against stuff or equivalently a broad decline in asset prices. Since this has been quite uninviting for the established classes the result has been a policy of monetary debasement. In the current irredeemable fiat currency systems of the world this amounts to central bank balance sheet expansions. The rudimentary aim of this policy is to maintain the existing stock of IOU claims upon central bank notes by debauching the central bank notes themselves.

The Extrapolative Misstep:

I think that the above is understood by a decent proportion of the investment community, however I believe that even these well-enlightened investors erroneously presume that this dynamic is bearish for the dollar against virtually everything. To be sure – I maintain that owning central bank assets (notably gold) as opposed to central bank liabilities is a worthwhile speculation, but I scarcely imagine that one should indiscriminately own foreign central bank notes against Federal Reserve notes. The reason is fairly simple when looking at the world holistically: the dollar lingers on as a major component of global central banking assets – resultantly; dollars still constitute a decent proportion of the ‘backing’ to many foreign central bank notes. So if you own gold against dollars for fear of monetary dilution via manipulations of the Fed’s balance sheet – I would suggest that you should own Federal Reserve notes against dollar-dependent foreign currencies for fear of implicit manipulations of global central bank balance sheets that would result from those manipulations of the Fed’s balance sheet. In a twisted irony it would seem that foreign central banks are forced into being at least as profligate as the Fed due to their holdings of dollars and IOU claims upon dollars. The only way a central banker can avoid this implicit profligacy is by contracting their respective dollar-dependent balance sheets – but this is unpalatable in so many ways.

The Analogy:

The way we have explained this over recent months has been to compare it to the US housing market. As mentioned a while back:

One must note that houses did appreciate against at least one thing during 2007-2009; housing derivatives! If you owned a house in the US, you no-doubt found that you could purchase more and more housing derivatives with your house as the housing collapse unfolded!

The above conceit is not difficult to understand — we all know that derivatives are premised upon their underlying assets. As the underlying rises and falls the levered derivative of one higher order moves in the same direction but with (usually) greater ferocity. Naturally then a housing derivative can easily become worthless with a less than 100% wipeout of the value of the underlying asset. In this way the deteriorating asset can appreciate against at least something — the derivatives that depend on it!

When it comes to the currency markets we have a similar scenario, but a great proportion of the investment community draw a blank and maintain that what must be bearish for the dollar against most things must be bearish for the dollar against its de facto derivatives – currencies that are ‘backed’ by dollars.

This is one pillar of my bullish stance on the dollar against other fiat currencies (the other being the unwinding of the implicit short positions on federal reserve notes via the medium of debt). If they debase the dollar, they debase them all – so if you believe that a) the Fed will be profligate and that b) foreign central banks will be slow to move away from the dollar, then maybe you should own dollars against dollar-dependent fiat currencies and not the other way round!

Analogously speaking; an expanding Fed balance sheet is to dollar-dependent central bank notes as a surprisingly abundant housing stock is to a bullish housing derivative!

The Balance of Assets & Liabilities for Irredeemable Fiat Currencies:

The more technical reason for this dynamic is that irredeemable fiat currencies trade at perennial discounts from imagined would-be ‘pars’. Before the early 1970s there was at least some vague attempt at maintaining redemption at some specific ‘par value’. This meant that if the market were to doubt the integrity of a currency issuer then that currency would fall to a ‘discount from par’. This would invite either a correcting drain on reserves (due to redemptions at par value), an outright debasement (more snidely referred to as a ‘revaluation’) or some kind of intervention to forestall the inevitable. But since there is no clearly identifiable promised ‘par’ at present we have a scenario where currencies trade at perennial discounts to the value that would be par if redemption were to resume with immediate effect.

The above characterizes the fact that fiat currencies are promises for maybe something (but probably nothing) at perhaps some time in the future (but probably never). In this way, the dollar-backed fiat currency represents a doubly precarious asset – for it’s a promise for maybe something maybe later (but probably nothing, never) for maybe something different at perhaps some later date (but probably nothing, never)!

Uh oh! They’re going to try to debase the dollar to ‘boost exports’!

Whereas this is rather exciting as a speculator, it’s quite frightening as a subject of a confused government. As Kyle Bass pointed out in this recent interview, the US government is probably going to try and ‘export themselves out’ of this problem by destroying the dollar:

How do you solve a problem where you’re running a 10% fiscal deficit? You’re not going to get growth in the absence of private sector credit demand, so the government’s idea right now is that we’re going to export our way out of this. And when I asked a senior member of the Obama administration last week ‘how are we going to grow exports if we won’t allow nominal wage deflation?’ And he says ‘we’re just going to kill the dollar’ I said ok – more you mean. So that’s the only answer – it’s a dead answer, but that’s where we’re headed. So if you made me the Tsar what would I do? I’d go out there and I’d try to cut a bunch of things, and GDP would drop and unemployment would go up and I’d be the persona non grata. But it would be the right decision for our country for the next ten years.

All I can say is that government officials are suckers for mechanistic and retrospective ways of thinking (they linearly correlate past movements and act on them going forward). It’s quite possible that they’ll become frustrated when the currency markets move ‘the wrong way’ in spite of all their efforts to ‘kill the dollar’. In this case they may justify over the top expansionary monetary policies. In this case we would have a platform for severe inflation where monetary authorities keep the debasement schemes at full blast until they see the results they want (a falling dollar vis-à-vis other currencies). I would imagine that the dollar would have to appreciate greatly for some time before they would see the results that they seek.

This is a really dangerous dynamic that has a good chance of coming to pass. For whereas central bankers basically know that they can’t expand their balance sheets to infinity without risking vicious price inflation, it would seem that the Fed is at a complete loss as to why it’s balance sheet expansions might actually lead to an appreciation of the dollar against other currencies (at first).

Aftab Singh is an independent analyst. He writes about markets & political economy at http://greshams-law.com .

© 2012 Copyright Aftab Singh - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014