Doc's Daily Commentary

Mind Of Mav

Death Of The Dollar Standard Part 3

Throughout the month of July, we’ve seen the “death of the Dollar” reported ad nauseum.

It’s easy to think that, especially since it gets reiterated in most media outlets.

I will take the contrarian view.

This is a short-term “downturn” in the Dollar and very soon the Dollar will rise a lot against the Euro – supported by the Federal Reserve itself.

US dollar Index (DXY)

If you zoom out to the 3Y chart you’ll see what everyone is being hysterical about. The dollar is dying! It was that low in 2018! This is the end! The Fed has done too much money printing! Zimbabwe and Weimar are coming to the US.

There is more to it though. The DXY is dominated by two currency rates and the most important one by far is EURUSD.

EURUSD makes up 57.6% of the DXY

And we’ve seen EURUSD rise from 1.14 to 1.18 since July 21st, 2020.

Why that date? On that date, the European Commission (basically the “government” of the EU) announced that there was an agreement for the historical rescue package for the EU. That showed the markets that the EU seems to be strong and resilient, it seemed to be united and therefore there are more chances in the EU, the Euro, and more chances taking risks in the EU.

Meanwhile, the US continued to struggle with the Coronavirus and some states like California went back to restricting public life. The US economy looked weaker and therefore the Euro rose a lot against the USD.

From a technical point of view, the DXY failed to break the 97.5 resistance in June three times – DXY bulls became exhausted and sellers gained control resulting in a pretty big selloff in the DXY.

Why the DXY is pretty useless

Considering that EURUSD is the dominant force in the DXY I have to say it’s pretty useless as a measurement of the US dollar. Why? Well, the economy is a global economy. Global trade is not dominated by trade between the EU and the USA. There are a lot of big exporting nations besides Germany, many of them in Asia. We know about China, Japan, South Korea etc. Depending on the business sector there are a lot of big exporters in so-called “emerging markets”. For example, Brazil and India are two of the biggest exporters of beef.

Now, what does that mean? It means that we need to look at the US dollar from a broader perspective. Thankfully, the Fed itself provides a more accurate Dollar index. It’s called the “Trade Weighted U.S. Dollar Index: Broad, Goods and Services”.

When you look at that index you will see that it didn’t really collapse like the DXY. In fact, it still is as high as it was on March 10, 2020! You know, only two weeks before the stock market bottomed out. How can that be explained?

Global trade, emerging markets, and global dollar shortage

Emerging markets are found in countries that have been shifting away from their traditional way of living towards being an industrial nation. Of course, Americans and most of the Europeans don’t know how life was 300 years ago. China already completed that transition. Countries like Brazil and India are on its way. The MSCI Emerging Market Index lists 26 countries. Even South Korea is included.

However, there is a big problem for Emerging Markets: Coronavirus and US Imports.

The good thing about import and export data is that you can’t fake it. Those numbers speak the truth. You can see that imports into the US haven’t recovered to pre-Corona levels yet. It will be interesting to see the July data coming out on August 5th. Also, you can look at exports from Emerging Market economies.

Let’s take South Korean exports YoY. You can see that South Korean exports are still heavily depressed compared to a year ago. Global trade hasn’t really recovered.

For July the data still has to be updated that’s why you see a “0.0%” change right now. Less US imports mean less US dollars going into foreign countries including Emerging Markets. Those currency pairs are pretty unimpressed by the rising Euro. Let’s look at a few examples. Use the 1Y chart to see what I mean.

Indian Rupee to USD

Brazilian Real to USD

South Korean Won to USD

What do you see if you look at the 1Y chart of those currency pairs? There’s no recovery to pre-COVID levels. And this is pretty bad for the global financial system. Why? According to the Bank of International Settlements, there is $12.6 trillion of dollar-denominated debt outside of the United States. Now the Coronavirus comes into play where economies around the world are struggling to go back to their previous levels while the currencies of Emerging Markets continue to be WEAK against the US dollar.

This is very bad. We’ve already seen the IMF receiving requests for emergency loans from 80 countries on March 23th. What are we going to see? We know Argentina has defaulted on their debt more than once and make jokes about it. But what happens if we see 5 Argentinas? 10? 20? Even 80?

Add to that that global travel is still depressed, especially for US citizens going anywhere. US citizens traveling to other countries is also a situation in which the precious US dollars would enter Emerging Market economies. But it’s not happening right now and it won’t happen unless we actually get a miracle treatment or the virus simply disappears.

This is where the treasury market comes into play. But before that, let’s quickly look at what QE (rising Fed balance sheet) does to the USD.

Let’s look at the Fed balance sheet at the max timeframe. You will see: as soon as the Fed starts the QE engine, the USD goes UP, not down! September 2008 (Fed first buys MBS), March 2009, March 2020. Is it just a coincidence? No, as I’ll explain below.

They’re correlated and probably even in causation. Oh and in all of those scenarios the stock market crashed, compared to February 2020, the Fed balance sheet grew by ONE TRILLION until March 25th, but the stock market had just finished crashing…can you please prove to me that QE makes stock prices go up? I think I’ve just proven the opposite correlation.

We’ll finish up this series tomorrow. 

 

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