Why are market participants scared of a strong dollar? Because for years there was a massive carry trade against the U.S. dollar predicated on a bet that constantly printing currency and cutting rates would never create inflation.
The U.S. dollar isn’t strong. The loss of purchasing power of the greenback is the largest of the past three decades. The U.S. dollar is only “strong” in relative terms against other currencies that are collapsing in a global currency debasement that comes after years of monetary excess.
The pound isn’t collapsing because of a misguided prime minister’s tax plan; it’s collapsing alongside the yen, which also saw the Bank of Japan intervene to try to stop its depreciation, the euro, the Swedish krona, the Norwegian and Danish krone, or most currencies.
In the past year up to the time of writing, the U.S. dollar index (DXY) has risen 19 percent and reached a twenty-year high. The yen is down 23 percent against the U.S. dollar, the euro has fallen 15 percent, the pound 17 percent, and the emerging market currency index has also fallen 14 percent. Even in China, the People’s Bank of China has had to intervene, like the Bank of Japan or the Bank of England, to control a massive depreciation against the U.S. dollar.
Welcome to the vacuum effect of the U.S. dollar that we mentioned months ago.
In periods of complacency, the world’s central banks play at being the Federal Reserve without having the world’s reserve currency or the legal security and financial balance of the United States. Many massively increase money supply without paying attention to the global and local demand for their currency, and in addition, governments issue more U.S. dollar-denominated debt, hoping low rates will make the financing of huge deficits affordable. Complacency builds, and all asset classes see massive inflows and elevated valuations because money is cheap and abundant—a monster multi-trillion carry trade with many bets on the long side and one short: the U.S. dollar.
All this, in turn, leads the global demand for U.S. dollars to increase, not because the Federal Reserve is conducting a restrictive policy, but because the comparison with others shows the alternative fiat currencies are much worse.
This is the hangover from the great monetary binge of 2020, which saw an unprecedented increase in the balance sheet of central banks and global money supply soar to all-time highs. Furthermore, the massive binge was directly targeted at government current spending. Now, the boomerang effect is vicious: high inflation, currency collapses, as well as an equities and bonds market crash.
You wanted “unconventional” responses to a crisis? You got the most conventional of them all: printing money and destroying the purchasing power of the currency. It’s been implemented for centuries with the same disastrous effects only to be dusted off by a new group of bureaucrats who promised that this time would be different.
The U.S. dollar isn’t strengthening because of a few, modest rate hikes; the world’s currency and asset bubble is deflating.
As we said months ago, the U.S. dollar has created the conditions to be the most demanded currency simply because other central banks have been much more reckless. It only took an inflationary process that the central banks themselves denied or called transitory to raise the alarm of a market with overly optimistic expectations.
Liquidity is often taken for granted, and what the world is living is the evidence that liquidity is crucial in the market and that the U.S. dollar is the house with the largest number of windows and doors in a fire. You may dislike it, get angry, or reject it, but it’s a fact. The U.S. dollar has proven to be the king, even destroying cryptocurrencies’ valuations in the process, because it has proven that liquidity matters more than quality thesis views.
The implications of a global currency debasement process like this are enormous: widespread wealth destruction, persistent inflation making citizens poorer, emerging market reserves evaporating making their recovery more difficult, earnings expectations plummeting ... and all this coming from a Federal Reserve move that means that its balance sheet has barely reduced and rates are still low, even in negative territory if you see real inflationary pressures and not market participants’ assumptions of inflation expectations, which are always artificially low.
What about gold? Gold is down in U.S. dollars but outperforming equities and bonds. However, gold is up in most global currencies.
The U.S. dollar can lose its status as world reserve currency, but it’s hardly feasible in the short term, because all contenders are implementing even more aggressive monetary excess policies. Think about Japan or the UK central bank trying to curb a yen or pound depreciation by printing even more money.
The next time you read from Keynesian consensus experts that massive stimulus plans are warranted because the models say there’s no risk, remind them that they built the models to always show that government and monetary excess is nonexistent and therefore the models are rubbish. The problem is that policymakers won’t learn because they benefit from inflation and currency depreciation. It’s a form of taxation and wealth transfer from the productive to the politically connected.
Many will blame the Federal Reserve for acting too quicky and aggressively, not for doing it too late and after too much. Most will demand more currency debasement and monetary excess. And the result will be the same. U.S. citizens are suffering the loss of purchasing power of their currency and the collapse of their investments while the rest of the world’s families and businesses are seeing their real wages vanish and their currencies become worthless. Cheap money is expensive. Always.
