Tuesday, May 3, 2011

How Low Can the Dollar Go?

So, just how low can the dollar go? Above are some technical charts detailing potential price movements. If you are a subscriber to Point and Figure chartology, there is even a price target.

On the fundamentals, the prospects for the dollar remain decidedly weak. In fact, there is a strong consensus in Washington D.C. - both among the Federal Reserve and elected officials in Congress to keep the dollar low. Their thinking is based on the premise that so long as the dollar continues to slide there will be great benefits to large American firms increasingly doing business on foreign shores, with particularly strong growth for those moving product in emerging markets. Additionally, interest rates must be kept low for borrowers to keep on making their payments - or more correctly, for the owners of MBS assets to keep on receiving their income streams. The all time lows were established in the pre-crash environment of summer 2008.

Discerning readers may note that the mention of 2008 mean that the market is set to crash again. This is not entirely untrue. However, the main difference between 2008 and 2011 is the level of government involvement in the market. The Fed is basically acting as a giant backstop to all risk on trades w/giant liquidity pumps. While markets may certainly experience corrections, they are unlikely to test the volatility swings seen in 2008.

The US Treasury Department noted this week that it is taking some steps towards responsible FISCAL policy. But this does nothing to alter the Federal Reserve's MONETARY policy. Quick summary - US finances are divided between monetary and fiscal policy. Monetary policy is controlled by the "Treserve" (Treasury + Federal Reserve). Fiscal policy is controlled by Congress (the power to tax and spend). Usually. This line of demarcation has been gradually blurred ever since 2008 and the alphabet soup of bailout programs. The latest announcement by the Treasury is aimed at cutting off subsidies towards state and local governments, hence the fiscal aspect. In contrast, talk of deficit limits are aimed at reigning in Fiscal policy among Congress which decides each year's budget. All of which are going nowhere fast and does nothing to alter the basic preserve of US politics - that in a pork barrel political world, politicians get voted into power based on how much they spend - not how much they cut.

Throw in the addition of Japanese monetary policy (estimated at $250-275 billion last month alone) and the world is easily awash in liquidity several times over. All of this excess cash seems set to continue raising all risk assets several times over - even in spite of the pain dealt to savers and consumers in developing nations.

So, how to profit from this type of environment? Well, precious metals and commodities will continue to climb but will deliver diminishing returns given the current rate of run-up. Another more conservative option is to buy equity index funds when they are trading below NAV and just buy and hold. Don't even open the newspaper but just sit tight and wait for inflation to take effect.

The bottom line: The dollar's decline is both fundamentally and technically all but ensured. While brief rallies may delay the dollar's inevitable decline they do nothing to stem the vast forces moving against it.
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