Rodney Dollarfield Doesn’t Need Respect
Friday, October 30, 2009
The U.S. dollar is doing a fair impression of the late Rodney Dangerfield – it gets no respect. But the buck doesn’t need respect to rally hard in the wake of a major squeeze…
A reader writes,
I never thought that you “confused the natures of Planet Real and Planet Paper.” You have always seemed positive that the King does not wear clothes, despite the calls for their [existence]. Mister Market is a monster gone awry, programmed by junkies, addicts, and molesters. Eventually, all will be consumed by the monster.
Best wishes. I really do like your writing.
Thanks for that. To clarify – the “Planet Real” versus “Planet Paper” concept was not exactly an epiphany. Nor was it an out of the blue realization, a major about face, or a significant change in stance. Instead, it was more a clarification of ideas already held – a sort of underscoring of what’s important.
Sometimes, there is a difference between knowing something and really “knowing” it… having a moderate level of comprehension versus really getting it deep in your bones. 2009 taught me how important it is not just to be aware of the differences between the “real” and “paper” worlds, but to compare and contrast them more routinely as a matter of habit.
Moving on to today’s topic… yesterday, my colleague Adam Lass pooh-poohed the recent surge in the U.S. dollar. He does not seem to think it a very big deal.
I have a sharply different take. As mentioned by yours truly just last week (and at various points prior),
The [U.S. dollar] situation is especially explosive because of the dollar’s link to equities, the unsustainably high valuations of export currencies among various U.S trading partners, and the aggressive manner in which everyone has piled into the dollar carry trade.
Adam closed his snub of the greenback by saying, “Like I said: Respect for the dollar has left the building.”
To which I say, indeed. The dollar gets less respect these days than Rodney Dangerfield in Ladybugs. But here is the thing. As far as the current explosive situation goes, “respect” really has very little to do with it.
To quickly recap a point made repeatedly in these pages: Thanks to an epic flood of liquidity and roaring revival of risk appetite, virtually all paper assets have gone up while the greenback has gone down.
The world, meanwhile, has gone “short” dollars in a very big way.
U.S.-based asset managers go short dollars when they send funds abroad to buy emerging market assets. Sovereign nations in Latin America, Europe and Asia short dollars when they issue dollar-denominated bonds. European merchants short dollars when they go out of their way to borrow in greenbacks (as opposed to local Euros).
The problem with all that shorting is that it creates the potential for a very big squeeze. As Commodore Vanderbilt mockingly said to his rival Daniel Drew (while mercilessly squeezing the stuffing out of him), “He who sells what isn’t his’n / Must buy it back or go to pris’n.”
A Paper Atlas
In other words, the buck is a paper atlas of sorts. It has the weight of the world on its scrawny shoulders because short dollar sales, in various forms, have by and large fueled the global rally. And so when the dollar’s perpetual downtrend comes to an end, the great 2009 rally more than likely does too. What’s more, the rally’s end has the potential to be violent. Extremely violent.
Don’t believe me? Just consider how rough a time of it the bulls had the first three days of this week. (The jury is still out for Thursday, as I write to you with one eye on the trading screens.)
When the dollar surged earlier this week, most everything risk-related went to hell. The euro folded like a cheap tent, giving up weeks’ worth of gains in one swift downdraft. The lead “commodity currencies” (Aussie and Canuck) stumbled on huge volume. Small-cap stocks went into utter freefall, vaporizing their up trend line in the process. (Small-caps rally, we hardly knew ye.) The transports puked. Brazil and Russia, the stars of the high-beta emerging market rally, saw their ETFs plummet on huge volume (symbols are EWZ and RSX respectively).
I could go on, but you probably get the gist. It was high volume, it was swift, and it was brutal, all in a tidy little 72-hour package. The bulls took a very hard hit to the solar plexus this week – the 80-year anniversary of the crash of 1929 by the way – and the rally in the buck was key in that.
Chicken or Egg?
One could ask, which caused which? Did the dollar’s surge cause a giant sucking in of breath as risk-related plays were suddenly (if temporarily) abandoned en masse? Or was it the reverse… a sudden loss of faith in risky assets that caused the greenback to go up?
It’s hard to say – maybe even impossible to say, or maybe both.
The point, though, is that the two events are deeply linked. For the past six months, “down with the dollar!” has meant “up with risk!” and vice versa.
It is extremely rare to see the likes of stocks, gold, oil and bonds all going up at the same time. It is something on the order of a once-in-50-years occurrence. When it happens, it is usually due to a flood of liquidity rushing into assets of all kinds… and American dollars rushing out of the United States to snap things up abroad.
As mentioned last week and at points prior, be careful out there. The trouble with bear market rallies fueled with a cynical cocktail of hope, cynicism and funny money is that they tend to end abruptly and violently. “Things fall apart”… and a number of key charts appear to be falling apart as we speak.
Even a modest dollar surge, in the present environment, is like the flashing of a giant red warning light – a portent of rally doom. Like Jim Rogers and Marc Faber, I believe the dollar’s long-run destiny is more or less oblivion. But also like Rogers and Faber, I would argue a meaningful dollar rally is now due. And if we do indeed see one, it will have little to do with respect.
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