Has the Faltering Dollar Reached Maximum Pessimism? (May 6, 2008)
Pessimism on the U.S. dollar is extremely high. Many commentators/analysts are talking up a doomsday scenario in which the dollar loses its status as reserve currency and plummets 50% or even 2/3 from its current value against other currencies (euro, yen pound, Chinese RMB, etc.)
Why do we care if the dollar plummets? Since the U.S. imports $500 billion petroleum and $2 trillion in other goods, then a collapse in the dollar would require exporters to raise prices in dollars lest they go bankrupt. Fom the U.S. side, we would experience stupendous price jumps in everything we import--most importantly, petroleum, which fuels our entire economy from agriculture to transportation.
As the dollar has lost 40% of its value in the past few years (falling from 120 to 72 relative to other currencies, as measured by the DXY Dollar Index), the pernicious effects have extended far beyond the obvious prices increases in imports. Astute reader Viperbear observed that the dollar's depreciation played a part in the U.S. housing bubble:
One of the keys to keep an eye on is the value of the dollar. Home prices skyrocketed on a declining dollar over the last decade and if the dollar regains much of the strength that it lost over the last 10 years, I expect home prices to plummet accordingly.There are only two fundamental economic conditions which would cause the dollar to rise relative to other world currencies:
1. The economies of the European Union, Japan, Britain and China fall even faster and harder than the U.S. economy, making the dollar a relative safe haven (the key word being "relative")
2. Interest rates rise in the U.S. to the degree that real yield (interest minus inflation) exceeds the inflation-adjusted interest available in other currencies and nations.
Since neither of those conditions appear to be operative at this point, I am skeptical of announcements that this is the bottom of the dollar's long painful fall. But then fundamental conditions don't always translate into price or relative value, so I asked frequent contributor Harun I. for a technical view of the notion that the pessimism stalking the U.S. Dollar was so extreme that it was signalling a reversal.
Of the many charts Harun was kind enough to submit, I have selected four to illustrate the points made in his commentary. All four charts are linked below; here is a close-up of the long-term chart of the dollar, followed by Harun's comments:
Like all things pessimism is relative. If we are long and prices are rising those short the market are pessimistic about the outcome of their trade and vice versa. For the trend-following trader/investor there is no pessimism, only opportunities to profit from others emotionally driven mistakes.Thank you, Harun, for sharing your analysis and charts. Some readers have noted that these charts are so large they don't fit in typical monitor screens. It's a tradeoff, and I reckon the detail of the charts in large format offsets the requirement to scroll around a bit.
Taking just one of the currencies which has risen against the dollar, here is the yen:
Even though the yen has risen markedly against the dollar, relative to gold it has lost value--as have all other currencies:
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