Dollar strength and global currency depreciation

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Why are market participants afraid of a strong dollar? Because for years there has been a massive carry trade against the US dollar based on the bet that constant currency printing and rate cuts would never create inflation.

The world has grown accustomed to betting on one thing – massive money supply growth – and the opposite – low inflation. Cheap money has become expensive, as I explained in my book “Escape from The Central Bank Trap”.

The US dollar is not strong. The loss of purchasing power of the greenback is the most important of the last three decades. The U.S. dollar is only “strong” in relative terms against other collapsing currencies in a global currency depreciation that comes after years of monetary excesses.

The pound is not collapsing because of a prime minister’s misguided tax plan; it is collapsing alongside the yen, which has also seen the Bank of Japan intervene to try to stem 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 US Dollar Index (DXY) has risen 19% to a 20-year high. The yen is down 23% against the US dollar, the euro is down 15%, the pound is down 17% and the emerging market currency index is also down 14%. Even in China, the People’s Bank of China had to intervene, like the Bank of Japan or the Bank of England, to control a massive depreciation against the US dollar.

Welcome to the US dollar vacuum effect that we mentioned months ago.

In times of convenience, the world’s central banks play at being the Federal Reserve without having the world’s reserve currency or the legal certainty and financial equilibrium of the United States. Many are massively increasing the money supply without paying attention to global and local demand for their currency, and on top of that, governments are issuing more US dollar-denominated debt, hoping that low rates will make financing huge deficits affordable. Complacency is setting in and all asset classes are seeing massive inflows and high valuations because silver is cheap and plentiful – a monster multi-trillion carry trade with many long bets and one short: the dollar American.

All this, in turn, leads to an increase in global demand for US dollars, not because the Federal Reserve is pursuing a restrictive policy, but because comparison with others shows that alternative fiat currencies are much worse.

This is the hangover of the Great Money Frenzy of 2020, which saw an unprecedented increase in central bank balance sheets and global money supply soar to historic highs. Moreover, the massive frenzy was aimed directly at the government’s current spending. Now, the boomerang effect is vicious: high inflation, collapsing currencies, as well as stock and bond crashes.

You wanted “unconventional” responses to a crisis? You have the most conventional of all: printing money and destroying the purchasing power of money. It was 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.

“Spend now and deal with the consequences later” was often repeated by consensus Keynesian economists, and now they shrug their shoulders and wonder why their “models didn’t work” as Christine Lagarde and Paul Krugman. Their models said inflation wouldn’t appear after printing trillions of dollars and euros at the same time, and none of them questioned whether the models were junk. Why didn’t they question their “role models”? Because the models said what they wanted to hear. However, inflation appeared, it was not short-lived, and the trap was set. An over-indebted, massively indebted world with gigantic imbalances built on top of each other due to the placebo effect of monetary laughing gas generated the “everything bubble” – and now it is bursting.

The US dollar is not strengthening due to some modest rate hikes; the global currency and asset bubble is deflating.

As we said months ago, the US dollar has created the conditions to be the most demanded currency simply because other central banks have been much more reckless. All it took was an inflationary process that the central banks themselves denied or qualified as transitory to give the alert to a market with overly optimistic expectations.

Liquidity is often taken for granted, and what the world is seeing is proof that liquidity is crucial in the market and that the US dollar is the house with the most doors and windows in the event of a fire. You may dislike it, get angry or reject it, but it’s a fact. The US Dollar has proven to be king, even destroying cryptocurrency valuations in the process, as it has proven that liquidity matters more than quality thesis views.

The implications of such a process of debasement of the global currency are enormous: widespread destruction of wealth, persistent inflation impoverishing citizens, evaporation of emerging market reserves making their recovery more difficult, falling earnings forecasts… and all this coming from a move by the Federal Reserve which means that its balance sheet has barely shrunk and rates are still low, even in negative territory if we see the real inflationary pressures and not the expectation assumptions inflation rates of market players, which are still artificially low.

What about gold? Gold is down in US dollars but is outperforming stocks and bonds. However, gold is rising in most global currencies.

The US dollar may lose its status as the world’s reserve currency, but this is hardly feasible in the short term, as all the contenders implement even more aggressive monetary excess policies. Think of Japan or the British central bank trying to stem the depreciation of the yen or the pound by printing even more money.

Next time you read from Keynesian consensus pundits that massive stimulus packages are justified because the models say there is no risk, remind them that they built the models to always show that excesses governmental and monetary are non-existent and that, therefore, the models are rubbish. The problem is that policymakers won’t learn because they profit from inflation and currency depreciation. It is a form of taxation and transfer of wealth from the productive to the politically connected.

Many will fault the Federal Reserve for acting too quickly and aggressively, not too late and after too much. Most will demand further monetary depreciation and monetary excesses. And the result will be the same. American citizens suffer from the loss of purchasing power of their currency and the collapse of their investments while the rest of the families and businesses of the world see their real wages disappear and their currencies lose all value. Cheap money is expensive. Still.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.

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Daniel Lacalle, Ph.D., is chief economist at the Tressis hedge fund and author of “Liberty or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”

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