The Strange Case Of The Falling Dollar - And What It Means For Gold

Authored by Alt-Market's Brandon Smith via Birch Gold Group,

Trillions of dollars in uncontrolled central bank stimulus and years of artificially low interest rates have poisoned every aspect of our financial system. Nothing functions as it used to. In fact, many markets actually move in the exact opposite manner as they did before the debt crisis began in 2008. The most obvious example has been stocks, which have enjoyed the most historic bull market ever despite all fundamental data being contrary to a healthy economy.

 

With a so far endless supply of cheap fiat from the Federal Reserve (among other central banks), as well as near zero interest overnight loans, everyone in the economic world was wondering where all the cash was flowing to. It certainly wasn’t going into the pockets of the average citizen. Instead, we find that the real benefactors of central bank support has been the already mega-rich as the wealth gap widens beyond all reason.  Furthermore, it is clear that central bank stimulus is the primary culprit behind the magical equities rally that SEEMS to be invincible.

To illustrate this correlation, one can compare the rise of the Fed’s balance sheet to the rise of the S&P 500 and see they match up almost exactly. Coincidence? I think not…

Another strangely behaving market factor that has gone mostly unnoticed has been the Dollar index (DXY). Beginning after the global financial crisis in 2008, the dollar’s value in reference to other foreign currencies initially moved in a rather predictable manner; collapsing in the face of unprecedented bailout and stimulus programs by the Fed, which required unlimited fiat creation from thin air. Naturally, commodities responded to fill the void in wealth protection and exploded in price. Oil markets in particular, which are priced only in the US dollar (something that is quickly changing today), nearly quadrupled. Gold witnessed a historic run, edging toward $2,000.

In the past few years, central banks have initiated a coordinated tightening policy, first by tapering QE, then raising interest rates, and now by decreasing their balance sheets. I would note that while oil and many other commodities plummeted in relative value to the dollar after tightening measures, gold has actually maintained a strong market presence, and has remained one of the best performing investments in recent years.

Something rather odd, however, has been happening with the dollar…

Normally, Fed tightening policies should cause an ever-increasing boost to the dollar index. Instead, the dollar is facing a swift plunge not seen since 2003.

 

What is going on here? Well, there are a number of factors at play.

First, we have a growing international sentiment against US treasury bonds (debt), which may be affecting overall demand for the dollar, and in turn, dollar value.  For example, one can see a relatively steady decline in US treasury holdings by Japan and China over the course of 2016, with China being the most aggressive in its move away from US debt:

We also have a subtle, yet increasing, international appetite for an alternative world reserve currency. The dollar has enjoyed decades of protection from the effects of fiat printing as the world reserve, but numerous countries including Russia, China, and Saudi Arabia are moving to bilateral trade agreements which cut out the US dollar as a mechanism. This will eventually trigger an avalanche of dollars flooding into the US from overseas, as they are no longer needed to execute cross-border trade. And, in turn the dollar will continue to fall in relative value to other currencies.

There is also the issue of coordinated fiscal tightening by central banks around the world, with the ECB and even Japan moving to cut off stimulus measures and QE.  What this means is, other currencies will now be appreciating in terms of Forex market value against the dollar, and in turn, the dollar index will decline further.  Unless the Federal Reserve acts more aggressively in its interest rate hikes, the dollar's decline will be brutal.

Finally, we also have the issue of nearly a decade of Fed stimulus that has gone without audit (except for the limited TARP audit, which shows tens of trillions in money/debt creation). We truly have no idea how much fiat was actually created by the Fed – but we can guess that it was a massive sum according to the seemingly endless rise in equities from a point of near total breakdown, funded by quantitative easing and stock buybacks. You cannot conjure a market rebound merely with debt. Eventually, that currency creation and the consequences will have to set a foot down somewhere, and it is possible that we are witnessing the results first in the dollar, as well as the Treasury yield curve, which is now flattening faster than it did just before the stock market crash in 2008.

A flat yield curve is generally a portent of economic recession.

 

I believe that this is just the beginning of troubles for the dollar and for US bonds. Which raises the question, how will the Fed react to a dollar market that is so far completely ignoring their tightening policies?

Here is where things get interesting.

Throughout 2017, I warned that the Fed would continue to raise interest rates (despite many people arguing to the contrary) and would eventually find an excuse to increase rates much faster than previously stated in their dot plots. I based this prediction on the fact that the Fed is clearly moving to pop the enormous ...
5 Published By - Zero Hedge - 2018.01.14. 04:00
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