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Trade Desk Thoughts:
Trading The Dollar Devalaution
Economic Releases: The Usd lost ground at 09:00 EDT on Tuesday, as the Case Schiller U.S. house price index printed at (only) -15.4%, with a drop in valuation that was better than expected, and an improvement on the previous month. That release coincided with the confirmation that Mr. Ben Bernanke, the Chairman of the Federal Reserve, has been nominated to a second term of office by U.S. President Obama.
Then at 10:00 EDT the Conference Board consumer confidence numbers posted a gain of 7% on the previous month to print at 54.1%. The equity markets jumped on the report that surveys 0.05% of the U.S. population, banking on the tiny amount of respondents actually reflecting well enough the other 99.95% of the U.S. population’s thoughts. That now raises the question as to whether equity markets are going into the worst performing month that Wall Street has historically each year, absorbing some tenuous links to risk tolerance.
As headlines, the house price index and consumer confidence numbers, pale into insignificance when compared to the role of the Fed Chairman. The four year term that starts on Jan 31 10 will require Senate approval, but has already been approved by the Banking Committee, and having seen what the Chairman dealt with over the last four years, it was little wonder that few were lining up to take the job.
Pile Of Debt: The responsibility of extracting the U.S. administration from the largest pile of forward debt the world has ever seen obviously required a person who has an inner knowledge of when that quantative easing program will be reversed, and more importantly how.
The markets are now going to test the trust placed in the Federal Reserve, and that will be seen in the valuation of risk tolerance, via the equity and oil markets. If the consensus opinion is that the U.S. can work its way out of the cycle of boom and bust that it is in, the dollar will get weaker as equity markets get stronger.
The global scales of fair value have risk on one side (equities), and safety on the other (Usd). Whatever the thought process is regarding when, how, and why the Fed will make its move, the reality is that however rocky the U.S. forward economic path may be, the Usd is still globally trusted.
Trust: The fact that the Federal Reserve owns a huge proportion, close to 50%, of the outstanding Treasury debt, and that the Fed also owns the press that will print, or not, more notes at will, makes little difference to the challenge of the job at hand for the market to value risk, and for Mr. Bernanke to extract the Fed from the commercial markets to the degree that they can run freely again.
It will always remain debatable as to what value any note has, whoever’s name is stamped on the front of it, when it is backed by no more than 10% of its actual value by an accountable reserve, and that is the conundrum that Mr. Bernanke will face.
Cotton and Paper: The Fed use fractional banking policies, in a system designed to leverage the reserve value of every Usd note in circulation. There is no gold standard to gauge the value of those notes, and as such the trust placed in the mesh of cotton and thread that makes up a U.S. note or bill is really all the intrinsic value that it has. Trust is fickle, and at a time that the global markets are trying to value risk, Mr. Bernanke’s position is hardly going to be seen as enviable.
Regional central bankers will be looking for regional currency values to stay close to where they currently are, the major pair economies will not want to see a deflating Usd value for two reasons; The majority of global reserves are held in Usd and gold deposits, and the regional economies need their own currency to hold steady so that their own path to forward growth is not impeded.
Weak Dollar Policy: At a time of global contraction a strong currency is not what is required, by any region, however, the U.S. looks to be the one region that literally cannot afford a stronger dollar. The insurmountable look to the U.S. Treasury debt numbers leave many to believe that the only way forward with sustainable growth, that has any chance at all of sustaining expansion numbers over and above the forward obligation to pay interest on the debt mountain, is with a lower value dollar.
The reduced Usd value will aid the current account and trade imbalance. That however will increase regional currency values, and also impact overseas reserve valuations. Traders saw the reaction last year to the dollar index dropping below the current read of 78.00, and monitored the savage buying reaction that hit the market at the 75.00 and 72.00 price point areas, as sovereign wealth funds and central banks started to voice publicly their disdain at the U.S. administration allowing the dollar to slide.
Devaluation: Forex traders will be looking again at whether the global economy is prepared to welcome Mr. Bernanke’s second term with a deflated, slimmed down version of the greenback, something that seems a ‘must-have’ for the Fed. That however can only happen in the current environment with an increasing global equity market, and a boisterous oil market arena that maintains a high level of long speculative interest.
This really is a global balancing act on forward debt commitments like no other seen since the Usd was devalued in 1971, when then President Richard Nixon scrapped the Usd link to the gold standard in the face of a gold reserve shortfall that had only 22% of the value of each dollar covered. The printing of notes to send overseas to fight foreign wars was overwhelming, and this represented the point in time where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits (sound familiar?).
The move back then created the dollar index, and the global markets started the transfer of gold debt to paper debt, as the Bretton Woods agreement unraveled, and the gold standard was replaced with a paper alternative.
35 Years Of Dollar Loss: Looking back, the devaluation of the Usd was not something that holders of U.S. debt had a choice to accept, it happened because the weight of debt, and the mere 22% of reserve holdings pushed the trust in the words “This note is legal tender for all debts public and private” to the absolute limit, could not sustain itself in its then current format. Fast forward 35 years and the reserve holding has shrank from 22%, which now looks to be a very impressive number, to 10% now under the fractional banking system.
Add to that the fact that paper has replaced a hard commodity as the reserve, and that the dollar index at 78.00 reflects the value of $1 then to being worth $0.78 now, and a clear picture is formed in regard to not really wanting anybody new to step into the breach in regard to the Federal Reserve Chairman role at this time. At a time that a dollar de-valuation is taking place that makes the 1971 gold standard move and the then historic 1972 Presidential visit to China look like drops in the Usd valuation story bucket, it has to be noted that the more things change, the more they stay the same.
Since 1973 the dollar index has dropped 22% in value, and is now looking as though a trip to 75.00 and 72.00 are a given, it is not if, but when they get hit, so long as equity and oil traders continue to bid up the valuation of global risk.
A tide Of Change: A new Chairman? Not right now. A new U.S. system of central banking? An open debate that only history will reveal the correct path of.
It may be advisable to maintain a watch on the S&P futures market at it trundles around the globe every 24 hours, because right now that is the market that is valuing global risk levels, and by default is valuing the Usd. The one major pair that more than any other on an intra-day basis reflects the ability for the dollar to break and hold is swissy. Add S&P futures direction to USD/CHF momentum, and forex traders have a window on the world of automated forex trade desks.
Congratulations Mr. B, and good luck with the master plan, because it seems that a new world order is not too far away; fortunately forex traders have a way to tap into that Usd read via S&P/Chf.
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