Say Goodbye to the Purchasing Power of the Dollar

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Hi everyone:
First I need to stipulate a few things:

  1. I am personal friends with Dave, Chris and Adam, and my views are well-known, being posted here on Peak Prosperity and on my blog oftwominds.com.

  2. If anything, my forecast of USD strength is out beyond Dave's–a move to 120 (from around 80 now) is baked in IMO, and 150 is definitely possible in a global credit-event.

As I have shown here, gold and the USD do not correlate very well over time. Both can rise in tandem, as each serves different functions. If you need to settle accounts in international trade (say within corporate accounts), moving $5 billion around in USD is easy.  Ultimately, currencies act as bills of exchange (what were used in Renaissance trading fairs, because there wasn't enough gold/silver in circulation to facilitate trade) and as stores of value, i.e. claims on resources, goods and services.

What few people appreciate is that the reserve currency (whatever it may be) has unique characteristics: the issuer has to run enormous trade deficits/print money to "export" enough currency to be useful to the global economy, and that currency becomes the "first claim" on goods, resources and services.  In very practical terms, when the non-reserve currencies melt down (a loss of faith occurs), the seller looks at the USD $100 bill and the alternative bills and takes the $100 bill, leaving the others essentially worthless. These characteristics have profound implications.  For one thing, export-based economies such as Russia, China, Japan and the EU cannot, by definition, issue the reserve currency because they aren't "exporting" any currency, they're importing it as trade surpluses.

Secondly, there is a zero-sum-game aspect to currency "wars."  The "winner" takes all in terms of utility and purchasing power. This is why the unofficial currency of numerous nations is the USD (in cash).

As a store of value, gold is king. But as a bill of exchange, it is not in the game.  Were a nation such as China to issue a gold-backed currency, whatever currency it "exported" would quickly disappear into savings accounts and central bank vaults as a store of value. There would not be enough floating to grease the enormous trade in the $160 trillion global economy. We still need a "bill of exchange" currency that is "exported" in size.  

This is why I keep saying gold and the USD could rise in tandem, Gold could skyrocket priced in other currencies and actually decline priced in USD.

There is much more to said about these USD issues, which are often non-inutitive and complex. As one last point, we should remember that the FX markets trade roughly $3 trillion a day, i.e. the entire balance sheet of the Federal Reserve trades every day.  The number of dollars needed to accomodate trade has risen dramatically, hence the huge trade deficits and money-printing.  

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http://www.zerohedge.com/news/2013-03-25/guest-post-say-goodbye-purchasing-power-dollar
It will be interesting to see what comes out in their comment thread. 

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I feel like I am always the bad guy… but I don't apologize.  I question things.  People like to make statements like they are some kind of immutable law… and there are no immutable laws in economics… not when the action is being played out by a collection of actors as fickle as human beings.

In economics, hope and faith coexist with great scientific pretension and also a deep desire for respectability. John Kenneth Galbraith
Charles said,
  What few people appreciate is that the reserve currency (whatever it may be) has unique characteristics: the issuer has to run enormous trade deficits/print money to "export" enough currency to be useful to the global economy, and that currency becomes the "first claim" on goods, resources and services.
While this sounds reasonable on the surface.. It struck me that the US has not always been such an unbalanced consumer of the worlds goods..  weren't we the manufacturing powerhouse in the 1950's and 1960's?  I checked.. and although the data only goes back to 1960, it turns out that the US trade balance was never in deficit until 1971 (what else happened that year.... hmmmmm?).  Anyway... we were the worlds reserve currency since post WWII, right?  So how did that work?  How did we get from 1945 - 1971 as the reserve currency without a trade deficit?

reference:  Foreign Trade: Data - Historical Series

Another thing…and this is my opinion, the dollar will never, ever, get to 150.  You don't think Big Ben, or whoever follows him, won't try to fight that tide?  Tiny Switzerland has been fighting the same battle…pegging the franc to the Euro…  and so far they have won.  You don't think the US can play the same game?  It's called the printing press… and in the end, the FED can and will print to infinity.   

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This is a good point.  A strong dollar would be a nightmare for Bernanke, Yellen & the rest of the Dove's at the Fed.  The way I see the game unfolding is that everyone debases and then last or close to last it's the Fed's turn.  That's when they really start printing.  There is just no way I see the politicians allowing a strong dollar to happen, especially when jobs are at the forefront of every voters mind.

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I've just had a chance to catch up. Great article and posts.
Jim wrote:

People like to make statements like they are some kind of immutable law.. and there are no immutable laws in economics.. not when the action is being played out by a collection of actors as fickle as human beings.
 I'm starting to think you are coming around to the social part of economics being a social science:)...just a subtle jab...I learn a lot from you, I hope I return the favor...
Jim wrote: Anyway... we were the worlds reserve currency since post WWII, right?  So how did that work?  How did we get from 1945 - 1971 as the reserve currency without a trade deficit?
How do we maintain the reserve currency at all?...
The sixties were particularly favorable to its exercise of inertial power. The prestige of the military and foreign policy establishment, following the successes of  World War II and the Marshal Plan, was high - far higher than now.

JK Galbraith - from "Economics, Peace, and Laughter"

Furthermore, why do you think the bitcoin was created in 2010? Why not earlier? They certainly had the technology to do it? These are the deeper social questions that need to be asked...

 

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See it all the time.  Head of nursing in our regional medical center in a small town in a low population density area getting just under 200K.  CEO here is getting 700+K … while the hospital was losing money.
Spinal fusions are indeed a big bucks item.  Consider that the Scandinavian countries have one of the best systems of musculoskeletal care and they do ONE TENTH the number of spinal surgeries that we do in the US.
And don't ask what outcomes are … check.  People have been known to lie.
 

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I frankly don't see the significance of the date of Bitcoin's release into the wild, which actually dates back to January, 2009.  The real elegance is not the cryptography itself, but rather the overall design, which relies on a motivated network of "miners" to maintain the digital DNA blockchain record… they are motivated to mine by earning Bitcoins, and mine they must in order to allow the integrity of the blockchain to be maintained.  Elegant.  
The original miners had no idea how valuable these would someday become… they threw them around like monopoly money (see reference below).  

This is open source software code.  There are lots of smart programmers out there… and they can all see all of the cards.   

More here;   http://www.wired.com/magazine/2011/11/mf_bitcoin/all/

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Jeff,
Nice to see you back but you sound a little grumpy.  Hope you unloaded AAPL … youch!
http://finance.yahoo.com/echarts?s=AAPL+Interactive#symbol=aapl;range=1y;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;
 

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Jim H -


Another thing…and this is my opinion, the dollar will never, ever, get to 150.  You don't think Big Ben, or whoever follows him, won't try to fight that tide?  Tiny Switzerland has been fighting the same battle…pegging the franc to the Euro…  and so far they have won.  You don't think the US can play the same game?  It's called the printing press… and in the end, the FED can and will print to infinity.   

Jim!  I like your questions!  It makes me think, and come up with new charts to explain the situation, if only to myself.  This whole dialog has been really helpful to me too. I am positive Ben will try to fight the tide.  So will the Swiss.  But let's be clear about something.  Nothing has really happened yet to scare depositors.  Its all been off in the periphery, carefully controlled by Brussels.  And still the Swiss have printed 471 billion dollars worth of CHF (76% of GDP) to keep the peg in place.  And this is before anything "real" comes down!  Can you imagine what happens when the eurozone gets *really* nervous?  Say when Spain's uninsured depositors get hit with losses because the Cyprus Template really is the template rather than just a one-off?  And then following that, France's property prices go into freefall, and regular people begin to figure out that when a bubble pops, bank failures and "depositor involvement" are not far behind?  And then at that point, the French want to print, the Germans don't, the French see it as a matter of national survival, and so POOF.  The eurozone explodes. I'll say it again, there are 17 trillion euros in deposits in the eurozone that will look for a place to hide once depositors in nations closer to the core realize they too are going to be "part of the solution" to banking issues in europe.  We've only seen the "early adopter"/'nervous nellie" move to date.  And that's cost the Swiss 76% of GDP to contain. Why will the Swiss stop printing?  If the threat to the eurozone becomes truly existential, its a really bad idea for the Swiss Central Bank to continue exchanging something of value (a CHF) for something that will vanish (a EUR).  At some point in this scenario, the Swiss central bank will come to the conclusion they've given away too much of their own currency in exchange for soon-to-be-confetti, and they will stop and impose capital controls instead.  But boy, will they have some big losses on the printing they've already done. During the 2008 crash, money market funds had 600 billion in redemptions in one day shortly after The Reserve fund broke the buck and froze redemptions.  Once confidence snaps, money moves in huge, uncontrollable size from places it perceives is dangerous. When that 17 trillion euros decides it wants to move, it will end up rocking the world, and central banks will, all on their own, decide that perhaps printing to maintain currency pegs isn't the best solution after all.  Why give away something of value in exchange for something that is going to turn to dust?  That just makes you the bagholder, with massive losses on the balance sheet.  And you for sure won't get that third term as head of the Central Bank.  And your legacy - shot to hell - "that guy who stupidly printed money and bought euros right before the eurozone died." This is the "USD goes to 150" scenario.  Its possible depending on how this scenario plays out, the "official" capital-controlled exchange rate will be different, so collecting on this bet might be difficult. This isn't my prediction of what WILL happen - its a scenario of what COULD happen wherein the USD could hit 150.  We can all estimate for ourselves what the odds of this coming to pass might be.  
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All,
I would like to thank you all for your well-reasoned and excellent observations about the state of the economy and our global financial system.  Like many of you I read this stuff constantly and have sought to pull the universal truths from the particulars - a philosophy of the economy if you will.

It is a natural impulse to observe a group of particulars (the growth of the money supply for instance) and attempt to combine it with other observations and create a working hypothesis that will predict the outcome of this whole experiment.  We are interested in how this will turn out, and how it  will affect the things that matter to us as individuals - our future.

The problem is - of course - that many of the particulars seem to be paradoxical such as the opposing forces of debt destruction and money printing.  My take aways from these collective observations are as follows:

  1.  Currency manipulation, debt destruction, trade deficits, financial engineering, interest rate manipulation, and other forms of economic "activity" have created a "strained web" of powerful and competing forces that are as complex as any natural system that exists in the universe.  This system is under unbelieveable pressure and is highly unstable due to its complexity.  Its laws are unknown and unknowable.

  2.  The system is influenced by the actions of flawed human beings who have competing interests and purposes which are not always clear to others.  There IS a component of conspiracy here that is undeniable, but no single "puppet master".  The Chinese, the Fed, the Banks, the government, are all simultaneously moving pieces around on the chessboard.  All of these actors are self-interested and some are actively hostile.  Some are malevolent, and some are incompetent.  Some operate under flawed theories and debunked economic models, and attempt to impose these upon the rest of us.

  3.  The system strains against real limits to growth, access to resources, population growth, and circumstances that change.  These global trends march forward relentlessly every hour of every day.

  4.  Exogenous shocks to other systems (North Korea, Iran, drought, Earthquakes) can dramatically destabilize or change the economic system in unpredictable ways.  These unpleasantries have a propensity to swoop in at the worst possible times.  Often they are catastrophes.

  5.  We are governed by fools and our population is at once uneducated (on these matters), deceived, plagued by entitlement, and unaware of the danger to their own well-being.  

  6.  Data is incomplete, manipulated, and difficult to interpret.  Interpreters are of varying quality and intent.

  7.  Thermodynamics demonstrates that ultimately complexity breaks down, and sometimes it does so very dramatically.

As a result of these observations, I have stopped attempting to predict an inflationary or deflationary outcome, the rise of totaltarianism or the resurgence of liberty, social chaos or devolution into a simpler lifestyle.  All I know is that something wicked this way comes - to repeat Dr. Martenson's original thesis - we are headed for a huge change in the way things are.  

Don't get too worried about the what or when - it is unknowable.  Just know that a big change is upon us and it is inevitable.  I will survive by being aware and resilient.

Rector

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I believe you truly captured the big picture and gave some clarity on what is knowable, what is not, and, given that, how to prepare.  The system is so complex, the data so incomplete, and our models imperfect enough that none of us can accurately predict the details or even the general shape of the outcome. Still, it's useful to consider the 5-10 most likely scenarios, consider their similarities and differences, what preparations are most likely to be useful in most or all of them, which in only a few, and which preparations are likely to be helpful in some scenarios, but detrimental in others.
Given all of the pontificators out there whose level of certainty about the outcome is unjustified by the data and models they use, we need to be constantly vigilant about maintaining the big picture and preparing for any number of possibilities.
Finally, once the first set of big changes are in motion (and many would argue with some justification that they are already) they may set off a second set of large and unpredictable forces that are much more likely to lead us into scenarios that have been considered by few if any of both the folks who have gone on the record with their predictions and those who have kept their predictions or hunches private.

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that is the way I also see it. Can you trust an organisation that imposes its authority through coecion and violence, hypocrisy, lies and deceit? Certainly not on my planet. The future has already been written and its not good for us folks.

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Jim, I understand the concept and framework, but timing within the context of human experience is crucial. I bring it up because the thread is discussing currency and bitcoin is an alternative. 


Wired: Bitcoin required no faith in the politicians or financiers who had wrecked the economy—just in Nakamoto’s elegant algorithms.

My point is that the concept was created and could only take hold after the faith had been shaken significantly by the events of the "great recession." In the end the bitcoin is an illusion. You can't subtract out the polititicians and financiers in a time when their power reigns supreme. It's amazing that they have let it go on for as long they have, but it makes me wonder if it didn't come from them in the first place?...could be a possibility. Regardless, in some ways I'm paying you a compliment. The concept  is elegant, but like all technology, the first manifestation is most often not the one that survives. The faith being shaken may make it possible for something "like bitcoin" to emerge.
Jim wrote: This is open source software code.  There are lots of smart programmers out there... and they can all see all of the cards.   
Hardly. I've worked with lots of programmers and their strengths more often than not lie in their ability to work from the bottom up. They overwhelmingly do not see all the cards. They often lack creativity and need a goal given to them. Once given the goal, then they are amazingly good at reaching it through writing code. Mind you I'm writing from my limited experience as we all do, there are always exceptions. I guess what I'm saying is what you have said to me (and I take to heart)... don't fall in love with your own theories, you may wind up like Kevin Kelly. The guy literally thinks he is a church of one (I'm rolling my eyes right now). Don't get me wrong the guy is really smart in his field, but when he starts crossing over into religion and philosophy, his ideas are pretty unsophisticated and have big gaping holes.  As far as the dollar? I think CHS's argument is just as valid as yours. We are all just speculating, and don't forget when things begin to get really desperate, the war machine revs up and changes everything.  Rector, Right on!
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Rector,That has got to be one of the most astute observations I've come across yet, and with the talent weighing in here (and elsewhere) that's quite an accomplishment. 
Congrats and thank you.

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Hi JIm:Skepticism and discussion are the foundations of advancement, so I welcome your critique–it's how I learn.
You raise an interesting point.  The US trade surplus post WW2 was starving Europe of the dollars needed to fund reconstruction, so the Marshall Plan was launched as the solution.  The Marshall Plan was basically printing up a ton of dollars and shipping them to Europe under the guise of low-interest loans. The US can either run a trade deficit or disburse dollars as loans.
While everything is contingent and unpredictable, that shouldn't be confused with mathematical relationships. For example, if the euro and yen depreciate, the DXY index will rise. That is as immutable as math.
As for the point that the chessboard is constantly full of moving pieces pursuing their own agendas, this is true but it can lead to the idea that it's all a jumble, i.e. chaos.  Beneath the apparent chaos, however, there may lurk powerful dynamics that limit the movements and effectiveness of various chess pieces. This is one reason why the Bilderburg Group etc. have such appeal–the idea that a few hands control the board satisfies our desire for agency. 
Chess is a good analogy because during the game there are many potential moves, but only a handful of moves lead to winning.  It is also an apt analogy because there are only 3 outcomes despite the endless possibilities along the way: winning, losing, or stalemate/draw.
The winning strategy, IMO, was perfectly summed up by Rector: resiliency.  It is unwise to place huge bets on any asset or financial instrument making a winner-take-all move. Ideally, we will be able to watch the gameboard without being too much at risk ourselves however the pieces move.

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Maybe the FED swap lines that seem to favor European banks so much are the new Marshall plan. 

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Hi Jim:That makes excellent sense.  This is a devious (and totally speculative)  thought, but if (say) $10 trillion in euros wanted to shift into dollars, that move would require deep, liquid markets to avoid destabilizing markets. The swap lines may also be facilitating the liquidity necessary for the transfer of financial assets out of euros into dollars.
This chart (from Dave's site) suggests the move out of euros is already well underway:
http://mdbriefing.com/peak-euro.shtml

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So Rector, if I can summarize your summary:
We're in deep doodoo
Our leaders are weasels
I've tried figuring out what will happen
It's too complicated
I've decided to await the logic of events, while remaining alert.
If you have a real life, I think that's an excellent plan.  However I have too much time on my hands, and a boundless curiosity, so my plan is a bit different.
I'm always looking for correlations between things.  I've found a number that seem to work, and more that I'm experimenting with.  My goal is to amass a set of these that taken together, gives me a sense of where the various parts of the world are currently heading - a sort of DEW Line that lets me peek over the horizon at threats that haven't made the news yet.  And it will (theoretically anyway) let me spot turning points while most are still focused on the current trend.  Back a few months ago my charts suggested the eurozone was heading into deflation while the MSM was focused on how Draghi had saved the system.  Deflation leads to GDP drops, and that's exactly what played out.  And my charts show, its not getting better.  [reporting lag is 45 days]
The new eurozone policy of bail-ins will only exacerbate this deflation - fair though that policy is.  I'll be able to watch this in - well, with that 45 day lag.  A month and a half from now I can tell you the impact of the Cyprus event, and possibly use that to predict what might happen the next time around.
I can explain (at least to my own satisfaction) why the US equity market continues to move up, and I don't need to add mysterious manipulators into my model to do it.  I can't predict how long it will continue - but I can definitely explain it.
I can rapidly fact-check news stories (usually takes less than 30 seconds) and (perhaps less usefully) blog comments I read.  I get ideas from everywhere.  People make hare-brained claims all the time, some of which I run down and find to be true, or they give me an idea and I run with it and something interesting comes from it.
Data is my best friend.  I know Fred, and the SDW, and the EIA, IMF, BIS, SSA, FAO, WEO, the CIA WFB, the BLS, freedom.org, and Quandl.  BLS has a lot of really good stuff - you can't take U-3 seriously, but you can repurpose their data to get at the truth.  One of my favorite metrics is the full-time-employment/population ratio - constructed thanks to BLS data.  It shows a very different picture of the "recovery" we're having.  Big surprise, right?
Not all data is created equal, but it can still be useful if you understand its limitations.  For instance, Spanish residential property prices and mortage loans outstanding are probably correctly accounted for on the up-slope, but almost certainly not on the way down.  Spanish authorities are lying about both.  But you can still use the size of the mountain created by the bubble to estimate how much the resulting explosion will be when the banks finally do blow up - and by looking at where the lies currently are, what progress has been made to date and how much remains undone.
A lot of Spanish depositors are going to be bailed-in.  Assuming they don't flee elsewhere.
So unlike your philosophy, mine is probably best summarized by the old TV Show, X-Files.
The Truth Is Out There! *

  • it just takes some effort to find
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[quote=davefairtex]The new eurozone policy of bail-ins will only exacerbate this deflation - fair though that policy is.  I'll be able to watch this in - well, with that 45 day lag.  A month and a half from now I can tell you the impact of the Cyprus event, and possibly use that to predict what might happen the next time around.
[/quote]
Dave,
I enjoy reading your comments and gather quite a few nuggets by doing so. I've heard others indicate that the bail-in is a "fair" way to handle the insolvency crisis. Could you explain how the folks who were smart enough to save should be penalized so the bankers will be made whole? Shouldn't the bank bond holders get the haircut?
You like to look over the horizon to see things before they're coming. Can you see anything good coming of the Cyprus bail-in?
Grover

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I envy you having the time to work this thing out.  Truly I do.

I too love to find the truth in the data - that's how I know we are in "deep doodoo" as you put it.  What I have observed is that - as you stated - my time available and analytical skills are limited and therefore my predictive power is likewise limited.  (That's why I pay for PP.com BTW)

I sometimes chuckle when I get to the end of Chris's articles.  We end up in the same place, regardless of how we get there with regards to the "what should I do" question.  How many times I have climbed the mountain of data only to arrive at the conclusion(s) that a. the situation is hopeless and cannot continue b. an exogenous shock to the system can destablilize it at any time c. my data is incomplete and d. others are actively working to prevent or change the outcome.  This is the unpredictable part - i.e. who could have predicted the Japanese earthquake, tsunami, and meltdown?  More incredibly, who foresaw that they would just keep on truckin' afterwards!?  I usually end up shrugging my shoulders and buying more gold.

When I was in my MBA program I soon realized that I wasn't a "quant", there were lots of people in my class with superior analytical and mathematical skills.  I could not contribute meaningfully in their world (it was embarrassing sometimes).  What I could do was take their product and weave it into a COA (course of action as we used to say in the Army).  There is a great need for direction, purpose, and motivation when ambiguity and the stakes are so high.  We called the phenomenon "analysis paralysis" and I am not suggesting you have it.  I am sure you are working towards an action you will benefit from in the future.

I don't think its "too complicated", I just understand that the system is complex and unpredictable. Will terrorists hit the Saudi Oil fields tomorrow morning?  What will the Fed do? Anyone who can answer those two questions correctly is divinely inspired.

Your posts were impressive because they were thorough and went against the grain a bit.  I will have to ride your data analysis coat tails.  The beauty of this website is that it allows me to have a conversation with people like you.  Thank you.