Smart talk plans

The creeping dollar is about to undo the Fed’s best plans

A lone deflationist on the lunatic fringe of the economy 30 years ago, I wrote in Barron’s and the San Francisco Sunday Examiner that a runaway dollar would eventually destroy us. Specifically, I claimed that a short squeeze on the dollars would send their value skyrocketing, making it difficult or impossible for anyone who owes dollars to repay them. I had already pitched this idea to a couple of finance professors at Ivy, who all had the same reaction: “What did you smoke??” Not professors Ivor Pearce and WP Hogan, however. It was their 1984 book, The Incredible Eurodollar, that awakened me to the potential disaster that was brewing in a dollar market far larger than all the others combined, including stocks and Treasuries. Could a tradable asset available in theoretically unlimited quantities from the central bank ever be dangerously scarce? “An interesting question,” admitted Professor Pearce in a telephone conversation we had at the time.

This possibility has fascinated me since my days as a floor trader at the Pacific Stock Exchange. It was not uncommon to see a stock soar simply because too many traders had bet against it. These panic-driven meltdowns blithely ignored poor “fundamentals” to generate rallies that tended to enrich the reckless and stupid at the expense of the well-informed. The latter invariably suffered financial ruin, even though many of them were very smart guys who could do the math. In one particularly memorable case, they calculated that a certain airline stock trading for around $80 was not worth half that. After the stock finally soared above $200, knocking quants over their heads and destroying financially promising young lives, the weirdly silly notion of “valuations” would never be the same for them. Or for me.

Short the old Wazoo

This is precisely where the biggest players in the global financial system are right now: dollars overdrawn and convinced that the math is on their side. It’s because it’s been so easy for them to make absurd amounts of money lending dollars out of the blue against any kind of debt instrument an MBA team could think of. This explains why the main venue for raising dollars, a virtual finance pleasure dome loosely known as the derivatives market, has reached over $2 quadrillion. Each penny represents offsetting bets for and against the dollar, with borrowers effectively being overdrawn. Even the little guy got in on the action, borrowing dollars to buy homes and cars, whether they were affordable or not. A dollar depreciated by inflation will make it easier for them to repay what they owe. In practice, however, and unfortunately for those who are over-housed and over-transported, the value of the dollar has recently skyrocketed against all other currencies and even gold. As a result, the emerging recognition of the economic harm this is certain to cause is starting to make investors nervous.

As stocks fell sharply last week, the dollar index hit a high of 103.93 which surpassed no less than three previous highs set since the start of 2017. It took enormous buying power to overcome these hurdles, implying that short-compressed nitromethane is now fueling the rising dollar. The trend looks almost certain to continue, so we can use the small but technically significant spike shown on the chart at 109.24 as our minimum upside target for now. No one in the administration is aware of the existence of 109.24, but its decisive breakout would put the Fed’s ostentatious “tightening” regime in mortal danger. Powell & Co. are supposed to manage our inflation expectations, but as the dollar continues to rise, it will become increasingly clear that the charlatans who run the central bank are running out of tricks to make us believe that they know what they are doing.

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Look for further pressure on the dollar to push the price of oil out of reach for consumers outside the United States. It will also increasingly weigh on mortgage borrowers, bursting the housing bubble and reversing the near-vertical rise in car prices. This will put the prices of US multinational products and services beyond the reach of global customers, ultimately crushing corporate profits. It will also put the Yen, Pound and Euro under huge pressure. Putin pegged Russian currency to gold to keep it from sinking into uselessness. This is a stopgap measure at best, as it relies on robust natural gas sales to keep the Russian economy from stagnating. But that’s not a solution for most other countries, because they don’t have enough gold stocks to run a bullion peg.

While investors may not understand the implications of a short dollar squeeze, the stock market reacted intuitively with ominous signs that a bear market has begun. But the stock’s 10% decline so far isn’t even a warm-up for what’s to come. Wait until the financial whales realize their bet on inflation is dead wrong. It might take them a while, so there’s still time for wary investors to batten down the hatches. If you google “dollar short squeeze”, you will find that virtually all comments on the subject relate to a squeeze conducted primarily by professional traders. It’s a far cry from the short squeeze I’ve been writing about for all these years. This pressure – the one that is actually happening – will be global and will affect everyone, not just the big banks’ trading desks. Inflation fears are about to collide with the much bigger deflationary reality of a rising dollar. The ignorant hacks who make up the news should ask their supposed experts how much more inflation the US is likely to have with the dollar soaring. Prefer to speak frankly to the boring chatter of the general public?